A Simple Tool to Help in Identifying Trend Reversal
There is a great deal of nonsense written about trends and using trend lines. Quite often - and maybe even the majority of the time trend lines aren't even drawn on a trending move and traders then cry when they lose money because of a trade they had based on the break of their line.
To be honest the concept of a trend is really one of the most simple tools in a trader's toolbox but the definition of a trend is normally forgotten and could actually help your trading considerably. Let us just cover the definition of a trend:
* Up trend A sequence of higher highs and higher lows
* Down trend A sequence of lower highs and lower lows
It really couldn't be much simpler than that.
Sometimes - and in spite of the number of lines that traders draw - this doesn't happen very often, a supporting line can be drawn across the lows in an up trend or above the highs in a down trend.
In most cases you can consider trading a break of the trend line. At this point you do have to be a little careful since if the previous low in an up trend (previous high in a down trend) is not exceeded there is still chance that price can go and retest the trend line and occasionally this can be at a new extreme.
You can see in this example how even though the trend line was broken the prior low in the sequence of higher lows was not penetrated. Following this price rallied to retest the trend line twice, the second time at a new high before it finally broke lower. You would normally expect momentum indicators to be showing a divergence at this point.
How can this be used in a practical way?
Well recently in Pro Commentary I had identified a peak in EURUSD that stalled at 1.2902 and I forecast a retracement to below 1.2800 with a favored target at 1.2745. In fact it only moved down to 1.2761. At these times when it is uncertain whether the correction is complete or whether price will move lower to target it is possible to consider the concept of a trend. Here is the 2-hour chart:
Following the break of the sequence of lower highs I confirmed to readers that they should expect to see the up trend resume with support between 1.2790-1.2805 holding and would eventually reach the 1.2976 high and probably later to 1.3180.
While identifying targets of where to find support or resistance requires knowledge of how price develops and the relationships in those moves followed by what sort of correction to expect, the concept of when the correction is complete is actually quite a simple process.
You can use this very simple tool with great effect.
Good luck with your trading.
Ian Copsey
Sunday, August 12, 2007
A Short Primer on Welles Wilder's "True Range" and "Average True Range"
A Short Primer on Welles Wilder's "True Range" and "Average True Range"
Respected trader and educator J. Welles Wilder developed "Average True Range" (ATR) as a tool for a more precise and realistic calculation of market's price activity and volatility.
The ATR is useful when calculating the directional movement of a market. Wilder defined the "True Range" of a market to be the greatest of the following periods:
* ¾ The distance from the session's high to its low.
* ¾ The distance from the previous session's close to the next session's high.
* ¾ The distance from the previous session's close to the next session's low.
A good example of a situation where True Range would be significantly larger than the normal daily trading range would be when price gaps occur on bar charts.
"True Range" measures market volatility and is an integral part of indicators such as ADX (Average Directional Movement) technical indicator, or several others, to identify the directional movement of a market. The ATR is the basic unit of measurement for Wilder's Volatility System.
Average True Range is a moving average of the True Range values over a period of time. The periods are the number of bars in a bar chart. If the chart displays daily data, then the period denotes days; in weekly charts, the period will stand for weeks, and so on. Wilder used a period of 7 for a default setting. Other common periods used are 14 and 20.
The Average True Range indicator identifies periods of high and low volatility in a market. High volatility describes a market with ongoing price fluctuation; low volatility is used to define a market with smaller price range activity.
When a market becomes increasingly volatile the ATR tends to peak, rising in value. During periods of little volatility the ATR bottoms out, decreasing in value. A market will usually keep the direction of the initial price move, though this is certainly not a rule. Analysts, therefore, tend to use Average True Range to measure market volatility and other technical indicators to help identify market direction.
Wilder has found that high ATR values often occur at market bottoms following a panic sell-off. Low Average True Range values are often found during extended sideways periods, such as those found at tops and after consolidation periods.
Measuring market volatility can help in identifying buy and sell signals and, additionally, risk potential. Markets with high price fluctuation offer more short-term risk/reward potential, because prices rise and fall in a shorter timeframe.
Wilder has a book, "New Concepts in Technical Trading Systems," where more information on True Range and the ATR indicator can be found.
Jim Wyckoff
Respected trader and educator J. Welles Wilder developed "Average True Range" (ATR) as a tool for a more precise and realistic calculation of market's price activity and volatility.
The ATR is useful when calculating the directional movement of a market. Wilder defined the "True Range" of a market to be the greatest of the following periods:
* ¾ The distance from the session's high to its low.
* ¾ The distance from the previous session's close to the next session's high.
* ¾ The distance from the previous session's close to the next session's low.
A good example of a situation where True Range would be significantly larger than the normal daily trading range would be when price gaps occur on bar charts.
"True Range" measures market volatility and is an integral part of indicators such as ADX (Average Directional Movement) technical indicator, or several others, to identify the directional movement of a market. The ATR is the basic unit of measurement for Wilder's Volatility System.
Average True Range is a moving average of the True Range values over a period of time. The periods are the number of bars in a bar chart. If the chart displays daily data, then the period denotes days; in weekly charts, the period will stand for weeks, and so on. Wilder used a period of 7 for a default setting. Other common periods used are 14 and 20.
The Average True Range indicator identifies periods of high and low volatility in a market. High volatility describes a market with ongoing price fluctuation; low volatility is used to define a market with smaller price range activity.
When a market becomes increasingly volatile the ATR tends to peak, rising in value. During periods of little volatility the ATR bottoms out, decreasing in value. A market will usually keep the direction of the initial price move, though this is certainly not a rule. Analysts, therefore, tend to use Average True Range to measure market volatility and other technical indicators to help identify market direction.
Wilder has found that high ATR values often occur at market bottoms following a panic sell-off. Low Average True Range values are often found during extended sideways periods, such as those found at tops and after consolidation periods.
Measuring market volatility can help in identifying buy and sell signals and, additionally, risk potential. Markets with high price fluctuation offer more short-term risk/reward potential, because prices rise and fall in a shorter timeframe.
Wilder has a book, "New Concepts in Technical Trading Systems," where more information on True Range and the ATR indicator can be found.
Jim Wyckoff
"Vibrating Prices" and the Trading Philosophies of W.D. Gann
"Vibrating Prices" and the Trading Philosophies of W.D. Gann
William Delbert (W.D.) Gann is regarded as one of the pioneers of technical analysis and market behavior. He wrote several books on stock and commodity trading and developed the well-known "Gann angles" and "Gann Fans."
Gann was born on a farm near Lufkin, Texas, in 1878. His rise to trading fame is a remarkable story. He was the oldest of many children on the farm, and did not even finish grade school. Back then, it was not uncommon for the oldest boy to quit school at a relatively young age and stay at home to help out on the farm.
However, W.D. did not want to be a farmer. He wanted to be a businessman. For a short period of time he worked for a brokerage in Texas while attending business school at night. He then set out for New York City in 1903.
In 1919, at the age of 41, Gann quit his job with a stock brokerage and set out on his own. He began publishing a daily market newsletter called the "Supply and Demand Letter." The newsletter covered both stocks and commodities and provided traders with his annual market forecasts.
In 1924, Gann's first book, "Truth of the Stock Tape," was published. A pioneering work on chart reading, it is still regarded as one of the best books ever written on the subject.
Gann's market forecasts during the Roaring Twenties were reportedly 85% accurate. The stock market in the 1920s was skyrocketing, but Gann didn't think the bull run would last. In his forecast for 1929, Gann predicted the stock market would hit new highs until early April, then experience a sharp break, and then resume with new highs until early September. Then it would top and afterward would come the biggest stock market crash in history.
After around 20 years in New York City, Gann moved to Miami, Florida for reasons of both health and personal preference. His "How to make Profits in Commodities" book came out shortly thereafter.
Following are the general tenets of Gann's trading philosophies and methods. I won't go into great detail on his specific methods in this feature. If you want to learn more about Gann's specific trading methods, I suggest you read his books, or books written about Gann, some of which are available at www.amazon.com.
Gann designed several unique techniques for studying price charts. His main theory uses three parameters to project changes in price trend and market direction. They are: Pattern, Price and Time. These parameters can exert their influence individually, with one or the other being more determinate under different conditions. But they are best applied in a balanced manner. The basic idea is that specific geometric price patterns and angles have special properties that can be used to predict future prices.
He believed the markets are geometric in design and in function, and they follow geometric laws when they're charted. All of Gann's techniques require that equal time and price intervals be used on the charts. Thus, a rise of one price unit over one period of time (1 x 1) will always equal a 45-degree angle. Gann believed that the ideal balance between time and price exists when prices rise or fall at a 45-degree angle relative to the time axis. This is called a 1 x 1 angle.
Gann angles are drawn between a significant bottom and top (or vice versa) at various angles. Deemed the most important by Gann, the 1 x 1 trend line signifies a bull market if prices are above the trend line, or a bear market if below the trend line. Gann felt a 1 x 1 trend line provides major support during an uptrend, and when the trend line is broken it signifies a major reversal in the trend. Gann identified nine significant angles, with the 1 x 1 being the most important.
Gann said each of his predetermined angles provide support and resistance depending on the trend. For example, during an uptrend the 1 x 1 angle tends to provide major support. A major reversal is signaled when prices fall below the 1 x 1 angled trend line. Prices should then be expected to fall to the next trend line (the 2 x 1 angle). As one angle is penetrated, expect prices to move and consolidate at the next Gann angle.
Prices have a way of repeating themselves--or "vibrating," as Gann put it. One can think of vibration in terms of periodic oscillation, the theory of waves, or cycles, as in cycle theory.
Gann said in his own words, "Through the law of vibration, every stock and commodity in the market place moves in its own distinctive sphere of activities, as to intensity, volume and direction. All the essential qualities of its evolution are characterized in its own rate of vibration. Stocks and commodities, like atoms, are really centers of energy, and therefore, they are controlled mathematically. They create their own field of action and power--power to attract and repel, which explains why certain stocks and commodities at times lead the market and turn dead at other times. Thus, to speculate scientifically it is absolutely necessary to follow Natural Law. Vibration is fundamental; nothing is except from its law. It is universal, therefore, applicable to every class of phenomena on the globe. Thus, I affirm, every class of phenomena whether in nature or in the markets, must be subject to the universal laws of causation, harmony and vibration."
There is no question that Gann's trading track record in the 1920s was truly remarkable. And, his trading methodology certainly has merit. However, I think the most important tenets of Gann's success were stated in a paper published by Gann's grandson, edited excerpts of which are below: "Delbert Gann of Lufkin, Texas, started with nothing. He and his family had no money, no education, and no prospects. But less than 40-years after overhearing businessmen talk on railroad cars in Texas, W.D. Gann was known around the world.
"Hard work pays. W.D. Gann rose early, worked late, and approached his business with great energy. Virtually all his education was self-administered. This teacher, writer, and prescient forecaster had a third-grade formal education. But he never stopped reading.
"Unconventional thinking may have its merits. W.D. was intellectually curious to an extraordinary degree. He was unafraid of unorthodox ideas, whether in finance or in other areas of life. He wasn't always right--none of us are--but he dared to pursue a better idea.
"And finally, the only lesson for traders I will venture to offer is W.D. Gann never stopped studying the market. Even after his forecasts happened, even after he achieved international acclaim. Although he believed in cycles, he also knew that markets are always changing and that decisions must be made based on today's conditions, not yesterday's."
W.D. Gann's personal characteristics, as related by his grandson, are strikingly similar to two other famous traders of Gann's same era: Jesse Livermore and Richard Wyckoff.
Jim Wyckoff
William Delbert (W.D.) Gann is regarded as one of the pioneers of technical analysis and market behavior. He wrote several books on stock and commodity trading and developed the well-known "Gann angles" and "Gann Fans."
Gann was born on a farm near Lufkin, Texas, in 1878. His rise to trading fame is a remarkable story. He was the oldest of many children on the farm, and did not even finish grade school. Back then, it was not uncommon for the oldest boy to quit school at a relatively young age and stay at home to help out on the farm.
However, W.D. did not want to be a farmer. He wanted to be a businessman. For a short period of time he worked for a brokerage in Texas while attending business school at night. He then set out for New York City in 1903.
In 1919, at the age of 41, Gann quit his job with a stock brokerage and set out on his own. He began publishing a daily market newsletter called the "Supply and Demand Letter." The newsletter covered both stocks and commodities and provided traders with his annual market forecasts.
In 1924, Gann's first book, "Truth of the Stock Tape," was published. A pioneering work on chart reading, it is still regarded as one of the best books ever written on the subject.
Gann's market forecasts during the Roaring Twenties were reportedly 85% accurate. The stock market in the 1920s was skyrocketing, but Gann didn't think the bull run would last. In his forecast for 1929, Gann predicted the stock market would hit new highs until early April, then experience a sharp break, and then resume with new highs until early September. Then it would top and afterward would come the biggest stock market crash in history.
After around 20 years in New York City, Gann moved to Miami, Florida for reasons of both health and personal preference. His "How to make Profits in Commodities" book came out shortly thereafter.
Following are the general tenets of Gann's trading philosophies and methods. I won't go into great detail on his specific methods in this feature. If you want to learn more about Gann's specific trading methods, I suggest you read his books, or books written about Gann, some of which are available at www.amazon.com.
Gann designed several unique techniques for studying price charts. His main theory uses three parameters to project changes in price trend and market direction. They are: Pattern, Price and Time. These parameters can exert their influence individually, with one or the other being more determinate under different conditions. But they are best applied in a balanced manner. The basic idea is that specific geometric price patterns and angles have special properties that can be used to predict future prices.
He believed the markets are geometric in design and in function, and they follow geometric laws when they're charted. All of Gann's techniques require that equal time and price intervals be used on the charts. Thus, a rise of one price unit over one period of time (1 x 1) will always equal a 45-degree angle. Gann believed that the ideal balance between time and price exists when prices rise or fall at a 45-degree angle relative to the time axis. This is called a 1 x 1 angle.
Gann angles are drawn between a significant bottom and top (or vice versa) at various angles. Deemed the most important by Gann, the 1 x 1 trend line signifies a bull market if prices are above the trend line, or a bear market if below the trend line. Gann felt a 1 x 1 trend line provides major support during an uptrend, and when the trend line is broken it signifies a major reversal in the trend. Gann identified nine significant angles, with the 1 x 1 being the most important.
Gann said each of his predetermined angles provide support and resistance depending on the trend. For example, during an uptrend the 1 x 1 angle tends to provide major support. A major reversal is signaled when prices fall below the 1 x 1 angled trend line. Prices should then be expected to fall to the next trend line (the 2 x 1 angle). As one angle is penetrated, expect prices to move and consolidate at the next Gann angle.
Prices have a way of repeating themselves--or "vibrating," as Gann put it. One can think of vibration in terms of periodic oscillation, the theory of waves, or cycles, as in cycle theory.
Gann said in his own words, "Through the law of vibration, every stock and commodity in the market place moves in its own distinctive sphere of activities, as to intensity, volume and direction. All the essential qualities of its evolution are characterized in its own rate of vibration. Stocks and commodities, like atoms, are really centers of energy, and therefore, they are controlled mathematically. They create their own field of action and power--power to attract and repel, which explains why certain stocks and commodities at times lead the market and turn dead at other times. Thus, to speculate scientifically it is absolutely necessary to follow Natural Law. Vibration is fundamental; nothing is except from its law. It is universal, therefore, applicable to every class of phenomena on the globe. Thus, I affirm, every class of phenomena whether in nature or in the markets, must be subject to the universal laws of causation, harmony and vibration."
There is no question that Gann's trading track record in the 1920s was truly remarkable. And, his trading methodology certainly has merit. However, I think the most important tenets of Gann's success were stated in a paper published by Gann's grandson, edited excerpts of which are below: "Delbert Gann of Lufkin, Texas, started with nothing. He and his family had no money, no education, and no prospects. But less than 40-years after overhearing businessmen talk on railroad cars in Texas, W.D. Gann was known around the world.
"Hard work pays. W.D. Gann rose early, worked late, and approached his business with great energy. Virtually all his education was self-administered. This teacher, writer, and prescient forecaster had a third-grade formal education. But he never stopped reading.
"Unconventional thinking may have its merits. W.D. was intellectually curious to an extraordinary degree. He was unafraid of unorthodox ideas, whether in finance or in other areas of life. He wasn't always right--none of us are--but he dared to pursue a better idea.
"And finally, the only lesson for traders I will venture to offer is W.D. Gann never stopped studying the market. Even after his forecasts happened, even after he achieved international acclaim. Although he believed in cycles, he also knew that markets are always changing and that decisions must be made based on today's conditions, not yesterday's."
W.D. Gann's personal characteristics, as related by his grandson, are strikingly similar to two other famous traders of Gann's same era: Jesse Livermore and Richard Wyckoff.
Jim Wyckoff
ADX for V Tops and V Bottoms
We have often described how the ADX (J. Welles Wilder's Average Directional Index) can be a useful tool for measuring the strength of trends. (Please review: Contradictions in using ADX and ADX Has it's Limitations if you are not familiar with our recommended use of ADX.) To briefly summarize our previous advice, we have found that when the ADX begins to rise it is telling us that a strong trend is developing.
We have often described how the ADX (J. Welles Wilder's Average Directional Index) can be a useful tool for measuring the strength of trends. (Please review: Contradictions in using ADX and ADX Has it's Limitations if you are not familiar with our recommended use of ADX.) To briefly summarize our previous advice, we have found that when the ADX begins to rise it is telling us that a strong trend is developing. A rising ADX has proven to be a particularly reliable indicator after a market has been going sideways for a while and then begins to trend. For best results, the ADX should begin its rise from a low level (less than 15 or 20) because the low level of the ADX indicates that a sideways basing pattern has been formed. Most of our applications of the ADX strategy have been predicated on finding these highly profitable patterns where a trend suddenly emerges after an extended sideways period.
Unfortunately not all trends begin with a sideways pattern. There are many V tops and V bottoms that our rising ADX strategy fails to capture. In a V pattern the ADX rises and then peaks out and declines. The ADX does not begin rising again in time to catch the change in direction in a timely fashion. By the time the ADX falls and then begins to rise again a major portion of the new trend will have already been completed. As we have pointed out in our previous Bulletins, any entry on a rising ADX that was not preceded by an extensive sideways period is not a very reliable pattern.
Recently in our research on using the ADX for trading stocks we have observed another ADX pattern that we believe shows great promise. This new ADX pattern signals very timely entries that allow us to profit from possible tops and bottoms that are V shaped.
Here is how these V shaped top and bottom patterns can easily be recognized:
1. Make sure that your plot of the ADX also includes the plot of the Plus DI and the Minus DI. The pattern begins when the ADX is above both the Plus DI and the Minus DI. Most often when the ADX is above both the Plus and Minus DI the ADX will be at a high level, perhaps greater than 30 or 35. The high level of the ADX indicates that the previous trend was a very strong one. Now we are going to try and catch the reversal of that strong trend.
2. With the ADX at a high level and declining, look for a crossing of the Plus DI and Minus DI. If the Minus DI crosses above the Plus DI it indicates that a strong up market has ended and weakness has set in. If the Plus DI crosses above the Minus DI it indicates that a strong downtrend has ended and a new uptrend can be expected.
3. These reversal patterns should be entered only as the market moves in the new direction. (We suggest that you use stops for entry triggers.) Once you have entered the trade you should expect a substantial move in the new direction.
4. Be sure to use a stop loss at the recent low or high of the previous trend. Be willing to make more than one attempt to catch the new trend. (Sometimes the Plus and Minus DI will cross back and forth more than once before the new trend emerges.)
We have found that this simple pattern identifies major changes in direction in almost any market. However you should be aware that the change of direction pattern we have described is not as reliable as the typical rising ADX pattern that starts with a basing action. However the trades that do work are exceptionally profitable and we know of no other method that is as timely at catching major changes in direction. Most traders take a great deal of personal satisfaction in quickly recognizing major changes in direction. This simple entry method can produce some truly outstanding trades and provides a welcome change from typical trend following strategies.
Our Phoenix Bond system uses this technique to identify major bottoms in the bond market. The same system also spots bottoms in individual stocks. To catch major tops we simply reverse the logic. Just put up some charts with the ADX and look for the pattern we have described in this Bulletin. We think you will be very surprised at its accuracy. Give us your comments and observations on the Forum.
Good luck and good trading.
by Chuck LeBeau
We have often described how the ADX (J. Welles Wilder's Average Directional Index) can be a useful tool for measuring the strength of trends. (Please review: Contradictions in using ADX and ADX Has it's Limitations if you are not familiar with our recommended use of ADX.) To briefly summarize our previous advice, we have found that when the ADX begins to rise it is telling us that a strong trend is developing. A rising ADX has proven to be a particularly reliable indicator after a market has been going sideways for a while and then begins to trend. For best results, the ADX should begin its rise from a low level (less than 15 or 20) because the low level of the ADX indicates that a sideways basing pattern has been formed. Most of our applications of the ADX strategy have been predicated on finding these highly profitable patterns where a trend suddenly emerges after an extended sideways period.
Unfortunately not all trends begin with a sideways pattern. There are many V tops and V bottoms that our rising ADX strategy fails to capture. In a V pattern the ADX rises and then peaks out and declines. The ADX does not begin rising again in time to catch the change in direction in a timely fashion. By the time the ADX falls and then begins to rise again a major portion of the new trend will have already been completed. As we have pointed out in our previous Bulletins, any entry on a rising ADX that was not preceded by an extensive sideways period is not a very reliable pattern.
Recently in our research on using the ADX for trading stocks we have observed another ADX pattern that we believe shows great promise. This new ADX pattern signals very timely entries that allow us to profit from possible tops and bottoms that are V shaped.
Here is how these V shaped top and bottom patterns can easily be recognized:
1. Make sure that your plot of the ADX also includes the plot of the Plus DI and the Minus DI. The pattern begins when the ADX is above both the Plus DI and the Minus DI. Most often when the ADX is above both the Plus and Minus DI the ADX will be at a high level, perhaps greater than 30 or 35. The high level of the ADX indicates that the previous trend was a very strong one. Now we are going to try and catch the reversal of that strong trend.
2. With the ADX at a high level and declining, look for a crossing of the Plus DI and Minus DI. If the Minus DI crosses above the Plus DI it indicates that a strong up market has ended and weakness has set in. If the Plus DI crosses above the Minus DI it indicates that a strong downtrend has ended and a new uptrend can be expected.
3. These reversal patterns should be entered only as the market moves in the new direction. (We suggest that you use stops for entry triggers.) Once you have entered the trade you should expect a substantial move in the new direction.
4. Be sure to use a stop loss at the recent low or high of the previous trend. Be willing to make more than one attempt to catch the new trend. (Sometimes the Plus and Minus DI will cross back and forth more than once before the new trend emerges.)
We have found that this simple pattern identifies major changes in direction in almost any market. However you should be aware that the change of direction pattern we have described is not as reliable as the typical rising ADX pattern that starts with a basing action. However the trades that do work are exceptionally profitable and we know of no other method that is as timely at catching major changes in direction. Most traders take a great deal of personal satisfaction in quickly recognizing major changes in direction. This simple entry method can produce some truly outstanding trades and provides a welcome change from typical trend following strategies.
Our Phoenix Bond system uses this technique to identify major bottoms in the bond market. The same system also spots bottoms in individual stocks. To catch major tops we simply reverse the logic. Just put up some charts with the ADX and look for the pattern we have described in this Bulletin. We think you will be very surprised at its accuracy. Give us your comments and observations on the Forum.
Good luck and good trading.
by Chuck LeBeau
Tuesday, July 24, 2007
Market participants
Top 10 Currency Traders % of overall volume, May 2006 Source: Euromoney FX survey[3] Rank Name % of volume
1 Deutsche Bank 19.26
2 UBS AG 11.86
3 Citigroup 10.39
4 Barclays Capital 6.61
5 Royal Bank of Scotland 6.43
6 Goldman Sachs 5.25
7 HSBC 5.04
8 Bank of America 3.97
9 JPMorgan Chase 3.89
10 Merrill Lynch 3.68
Unlike a stock market, where all participants have access to the same prices, the forex market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest investment banking firms. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle. As you descend the levels of access, the difference between the bid and ask prices widens. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the forex market are determined by the size of the “line” (the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After that there are usually smaller investment banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail forex market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown markedly over the 2001-2004 period in terms of both number and overall size” Central banks also participate in the forex market to align currencies to their economic needs.
[edit] Banks
The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account.
Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for small fees. Today, however, much of this business has moved on to more efficient electronic systems, such as EBS (now owned by ICAP), Reuters Dealing 3000 Matching (D2), the Chicago Mercantile Exchange, Bloomberg and TradeBook(R). The broker squawk box lets traders listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few years ago.
[edit] Commercial companies
An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.
[edit] Central banks
National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Milton Friedman argued that the best stabilization strategy would be for central banks to buy when the exchange rate is too low, and to sell when the rate is too high — that is, to trade for a profit based on their more precise information. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading.
The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives, however. The combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 1992-93 ERM collapse, and in more recent times in Southeast Asia.
1 Deutsche Bank 19.26
2 UBS AG 11.86
3 Citigroup 10.39
4 Barclays Capital 6.61
5 Royal Bank of Scotland 6.43
6 Goldman Sachs 5.25
7 HSBC 5.04
8 Bank of America 3.97
9 JPMorgan Chase 3.89
10 Merrill Lynch 3.68
Unlike a stock market, where all participants have access to the same prices, the forex market is divided into levels of access. At the top is the inter-bank market, which is made up of the largest investment banking firms. Within the inter-bank market, spreads, which are the difference between the bid and ask prices, are razor sharp and usually unavailable, and not known to players outside the inner circle. As you descend the levels of access, the difference between the bid and ask prices widens. This is due to volume. If a trader can guarantee large numbers of transactions for large amounts, they can demand a smaller difference between the bid and ask price, which is referred to as a better spread. The levels of access that make up the forex market are determined by the size of the “line” (the amount of money with which they are trading). The top-tier inter-bank market accounts for 53% of all transactions. After that there are usually smaller investment banks, followed by large multi-national corporations (which need to hedge risk and pay employees in different countries), large hedge funds, and even some of the retail forex market makers. According to Galati and Melvin, “Pension funds, insurance companies, mutual funds, and other institutional investors have played an increasingly important role in financial markets in general, and in FX markets in particular, since the early 2000s.” (2004) In addition, he notes, “Hedge funds have grown markedly over the 2001-2004 period in terms of both number and overall size” Central banks also participate in the forex market to align currencies to their economic needs.
[edit] Banks
The interbank market caters for both the majority of commercial turnover and large amounts of speculative trading every day. A large bank may trade billions of dollars daily. Some of this trading is undertaken on behalf of customers, but much is conducted by proprietary desks, trading for the bank's own account.
Until recently, foreign exchange brokers did large amounts of business, facilitating interbank trading and matching anonymous counterparts for small fees. Today, however, much of this business has moved on to more efficient electronic systems, such as EBS (now owned by ICAP), Reuters Dealing 3000 Matching (D2), the Chicago Mercantile Exchange, Bloomberg and TradeBook(R). The broker squawk box lets traders listen in on ongoing interbank trading and is heard in most trading rooms, but turnover is noticeably smaller than just a few years ago.
[edit] Commercial companies
An important part of this market comes from the financial activities of companies seeking foreign exchange to pay for goods or services. Commercial companies often trade fairly small amounts compared to those of banks or speculators, and their trades often have little short term impact on market rates. Nevertheless, trade flows are an important factor in the long-term direction of a currency's exchange rate. Some multinational companies can have an unpredictable impact when very large positions are covered due to exposures that are not widely known by other market participants.
[edit] Central banks
National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies. They can use their often substantial foreign exchange reserves to stabilize the market. Milton Friedman argued that the best stabilization strategy would be for central banks to buy when the exchange rate is too low, and to sell when the rate is too high — that is, to trade for a profit based on their more precise information. Nevertheless, the effectiveness of central bank "stabilizing speculation" is doubtful because central banks do not go bankrupt if they make large losses, like other traders would, and there is no convincing evidence that they do make a profit trading.
The mere expectation or rumor of central bank intervention might be enough to stabilize a currency, but aggressive intervention might be used several times each year in countries with a dirty float currency regime. Central banks do not always achieve their objectives, however. The combined resources of the market can easily overwhelm any central bank. Several scenarios of this nature were seen in the 1992-93 ERM collapse, and in more recent times in Southeast Asia.
Market size and liquidity
The foreign exchange market is unique because of:
its trading volume,
the extreme liquidity of the market,
the large number of, and variety of, traders in the market,
its geographical dispersion,
its long trading hours - 24 hours a day (except on weekends).
the variety of factors that affect exchange rates,
According to the BIS [1], average daily turnover in traditional foreign exchange markets was estimated at $1,880 billion. Daily averages in April for different years, in billions of US dollars, are presented on the chart below:
Global foreign exchange market turnover:
$621 billion
$1.26 trillion in derivatives, ie
$208 billion in outright forwards
$944 billion in forex swaps
$107 billion in FX options.
Exchange-traded forex futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts. Forex futures volume has grown rapidly in recent years, but only accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).
Average daily global turnover in traditional foreign exchange market transactions totaled $2.7 trillion in April 2006 according to IFSL estimates based on semi-annual London, New York, Tokyo and Singapore Foreign Exchange Committee data. Overall turnover, including non-traditional foreign exchange derivatives and products traded on exchanges, averaged around $2.9 trillion a day. This was more than ten times the size of the combined daily turnover on all the world’s equity markets. Foreign exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management assets, particularly of hedge funds and pension funds. The diverse selection of execution venues such as internet trading platforms has also made it easier for retail traders to trade in the foreign exchange market. [2]
Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 32.4% in April 2006.
The ten most active traders account for almost 73% of trading volume, according to The Wall Street Journal Europe, (2/9/06 p. 20). These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually only 0-3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203. Minimum trading size for most deals is usually $100,000.
These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100 / 1.2300 for transfers, or say 1.2000 / 1.2400 for banknotes or travelers' checks. Spot prices at market makers vary, but on EUR/USD are usually no more than 3 pips wide (i.e. 0.0003). Competition has greatly increased with pip spreads shrinking on the major pairs to as little as 1 to 2 pips.
its trading volume,
the extreme liquidity of the market,
the large number of, and variety of, traders in the market,
its geographical dispersion,
its long trading hours - 24 hours a day (except on weekends).
the variety of factors that affect exchange rates,
According to the BIS [1], average daily turnover in traditional foreign exchange markets was estimated at $1,880 billion. Daily averages in April for different years, in billions of US dollars, are presented on the chart below:
Global foreign exchange market turnover:
$621 billion
$1.26 trillion in derivatives, ie
$208 billion in outright forwards
$944 billion in forex swaps
$107 billion in FX options.
Exchange-traded forex futures contracts were introduced in 1972 at the Chicago Mercantile Exchange and are actively traded relative to most other futures contracts. Forex futures volume has grown rapidly in recent years, but only accounts for about 7% of the total foreign exchange market volume, according to The Wall Street Journal Europe (5/5/06, p. 20).
Average daily global turnover in traditional foreign exchange market transactions totaled $2.7 trillion in April 2006 according to IFSL estimates based on semi-annual London, New York, Tokyo and Singapore Foreign Exchange Committee data. Overall turnover, including non-traditional foreign exchange derivatives and products traded on exchanges, averaged around $2.9 trillion a day. This was more than ten times the size of the combined daily turnover on all the world’s equity markets. Foreign exchange trading increased by 38% between April 2005 and April 2006 and has more than doubled since 2001. This is largely due to the growing importance of foreign exchange as an asset class and an increase in fund management assets, particularly of hedge funds and pension funds. The diverse selection of execution venues such as internet trading platforms has also made it easier for retail traders to trade in the foreign exchange market. [2]
Because foreign exchange is an OTC market where brokers/dealers negotiate directly with one another, there is no central exchange or clearing house. The biggest geographic trading centre is the UK, primarily London, which according to IFSL estimates has increased its share of global turnover in traditional transactions from 31.3% in April 2004 to 32.4% in April 2006.
The ten most active traders account for almost 73% of trading volume, according to The Wall Street Journal Europe, (2/9/06 p. 20). These large international banks continually provide the market with both bid (buy) and ask (sell) prices. The bid/ask spread is the difference between the price at which a bank or market maker will sell ("ask", or "offer") and the price at which a market-maker will buy ("bid") from a wholesale customer. This spread is minimal for actively traded pairs of currencies, usually only 0-3 pips. For example, the bid/ask quote of EUR/USD might be 1.2200/1.2203. Minimum trading size for most deals is usually $100,000.
These spreads might not apply to retail customers at banks, which will routinely mark up the difference to say 1.2100 / 1.2300 for transfers, or say 1.2000 / 1.2400 for banknotes or travelers' checks. Spot prices at market makers vary, but on EUR/USD are usually no more than 3 pips wide (i.e. 0.0003). Competition has greatly increased with pip spreads shrinking on the major pairs to as little as 1 to 2 pips.
Thursday, July 12, 2007
Friday, July 6, 2007
Thursday, July 5, 2007
Pound Targets 2.0200 as BoE Hikes
By DailyFX - As expected the Bank of England hiked its overnight rate by 25bp to 5.75% expanding its interest...
... rate advantage against the dollar, euro and the yen, but in its post rate hike statement the UK central bank tempered its hawkishness by noting that, CPI inflation is likely to continue to fall back to around the 2% target in the course of this year.
Still the MPC members left the possibility of further rate hikes
on table by stating that, Credit and broad money continue to grow
rapidly. The pace of expansion of the world economy remains
robust .Although pay pressures remain muted, the margin of spare
capacity in businesses appears limited and most indicators of pricing
pressure remain elevated.
From the wording of the statement it is clear that UK central bankers
continue to be concerned about the double digit growth of the countrys
M3 money supply and will remain vigilant in containing further credit
expansion. Therefore, while for the time being the BoE appears to be
sidelined, chances are good that it will raise rates once again to 6%
level before the years end and this theme should provide support for
the pound against the other majors over the next several months.
In the near term the currency could come under some profit taking
pressure in a classic buy the rumor sell the news dynamic. Indeed, the
unit had a very hard time breaking above the 2.0200 barrier in the
aftermath of the release and was actually pulled lower right after the
news before rebounding smartly. Whether it can clear the 2.0200 level
and head higher from here, will depend in large part on US data in the
next two days.
If both ISM services and the NFP miss their targets the pound could
well catapult higher, zeroing in on the 2.0500 figure. If US economy
show material signs of slowdown, the pound will effectively become the
only show in town for speculative capital seeking to capture ever
increasing yields. If on the other hand, the market sees some positive
news out of the US docket, cable could come in for a round of profit
taking as traders will reason that BoE will stand down for at least
several months in a row before implementing further rate hikes.
Nevertheless, the pivotal 2.000 level which only a short while ago was
considered to be resistance in the pair, will now become support as
relative growth and relative interest rate differentials make cable the
magnet of speculative order flow in the currency market for the time
being.
DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com
FXCM, L.L.C.® assumes no responsibility for errors, inaccuracies or
omissions in these materials. FXCM, L.L.C.® does not warrant the
accuracy or completeness of the information, text, graphics, links or
other items contained within these materials. FXCM, L.L.C.® shall not be
liable for any special, indirect, incidental, or consequential damages,
including without limitation losses, lost revenues, or lost profits that
may result from these materials. Opinions and estimates constitute our
judgment and are subject to change without notice. Past performance is
not indicative of future results
... rate advantage against the dollar, euro and the yen, but in its post rate hike statement the UK central bank tempered its hawkishness by noting that, CPI inflation is likely to continue to fall back to around the 2% target in the course of this year.
Still the MPC members left the possibility of further rate hikes
on table by stating that, Credit and broad money continue to grow
rapidly. The pace of expansion of the world economy remains
robust .Although pay pressures remain muted, the margin of spare
capacity in businesses appears limited and most indicators of pricing
pressure remain elevated.
From the wording of the statement it is clear that UK central bankers
continue to be concerned about the double digit growth of the countrys
M3 money supply and will remain vigilant in containing further credit
expansion. Therefore, while for the time being the BoE appears to be
sidelined, chances are good that it will raise rates once again to 6%
level before the years end and this theme should provide support for
the pound against the other majors over the next several months.
In the near term the currency could come under some profit taking
pressure in a classic buy the rumor sell the news dynamic. Indeed, the
unit had a very hard time breaking above the 2.0200 barrier in the
aftermath of the release and was actually pulled lower right after the
news before rebounding smartly. Whether it can clear the 2.0200 level
and head higher from here, will depend in large part on US data in the
next two days.
If both ISM services and the NFP miss their targets the pound could
well catapult higher, zeroing in on the 2.0500 figure. If US economy
show material signs of slowdown, the pound will effectively become the
only show in town for speculative capital seeking to capture ever
increasing yields. If on the other hand, the market sees some positive
news out of the US docket, cable could come in for a round of profit
taking as traders will reason that BoE will stand down for at least
several months in a row before implementing further rate hikes.
Nevertheless, the pivotal 2.000 level which only a short while ago was
considered to be resistance in the pair, will now become support as
relative growth and relative interest rate differentials make cable the
magnet of speculative order flow in the currency market for the time
being.
DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com
FXCM, L.L.C.® assumes no responsibility for errors, inaccuracies or
omissions in these materials. FXCM, L.L.C.® does not warrant the
accuracy or completeness of the information, text, graphics, links or
other items contained within these materials. FXCM, L.L.C.® shall not be
liable for any special, indirect, incidental, or consequential damages,
including without limitation losses, lost revenues, or lost profits that
may result from these materials. Opinions and estimates constitute our
judgment and are subject to change without notice. Past performance is
not indicative of future results
Sunday, May 6, 2007
Dollar Slid on Weaker-than-Expected Payrolls
The dollar pared some of its gains after US Labor Department reported the economy added fewer jobs than expected in April. The greenback weakened to 1.3610 versus the dollar and tested 120 level against the yen.
US non-farm payrolls came out at 88k, below the consensus of 100k. March payrolls were revised slightly downward from 180k to 177k. The unemployment rate rose as expected from 4.4% to 4.5%. Average earnings rose 0.2% in April, below the forecast and previous month’s reading of 0.3%. Following the weaker than expected report, the dollar failed to retain its gains from robust manufacturing data released earlier this week. The Fed is widely expected to cut interest rates later in the year, while the ECB and BOE are likely to raise rates further. The dollar moves back and forth this week against the euro and sterling around the lows, however the overall sentiment over the dollar is still tilted to negative.
Meanwhile, the Canadian dollar edged up against the dollar after a report showed Canada Ivey PMI fell from 67.7 to 60.9 in April.
US non-farm payrolls came out at 88k, below the consensus of 100k. March payrolls were revised slightly downward from 180k to 177k. The unemployment rate rose as expected from 4.4% to 4.5%. Average earnings rose 0.2% in April, below the forecast and previous month’s reading of 0.3%. Following the weaker than expected report, the dollar failed to retain its gains from robust manufacturing data released earlier this week. The Fed is widely expected to cut interest rates later in the year, while the ECB and BOE are likely to raise rates further. The dollar moves back and forth this week against the euro and sterling around the lows, however the overall sentiment over the dollar is still tilted to negative.
Meanwhile, the Canadian dollar edged up against the dollar after a report showed Canada Ivey PMI fell from 67.7 to 60.9 in April.
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