There are many ways to trade the forex markets and one of the new popular tools is binary options. Some of the benefits of these financial products are that they are simple to use and you know exactly how much it costs and how much you can win. Also binary options let you to benefit from forecasting short-term fluctuations.

The strong dollar

February 26th, 2010

It is interesting to see how the FOREX market moves in waves and trends.

Not that long ago everyone was talking and blogging about the weak dollar, the end of America’s economic hegemony and its unsolvable deficit, deflation and the search for a replacement to the greenback.

Just a few months later the dollar has appreciated by 10% and the same bloggers are starting to worry if this dollar strength will have dire consequences. Here this discussion is focused on the USD versus Euro rate, a good summary of dollar strength or weakness.

This is all a matter of perspective. In my mind the EUR fluctuates in a big range [1.20-155] and this is where it belongs. Parity of purchasing power is a concept that traders and short-term investors tend to forget, but this is truly what defines the exchange rate. There are arbitrages from real good markets that guarantee that the dollar cannot stay too strong against the euro for  a prolonged period of time, and vice versa.

This fundamental truth is getting truer and truer and this is what guarantees that PPA theory will have its moment of glory. This is truer because the world is more integrated and arbitrages in real goods are easier and more predominant.

For example retired people in Europe may decide to buy their second home in Spain or in Florida. In the upper middle class this is common and the level of the exchange rate will be a significant determinant in their choice. As flying is easy and cheap, it does not make much difference to fly from Budapest to Barcelona or Miami.

The Internet facilitates the buying of all kinds of products that will be manufactured on the continent with the more favorable exchange rate. If one of the currencies were to diverge too much, natural commerce adjustments will occur that will modify supply demand to reverse the imbalance and the trend.

America and Europe are getting more alike, culturally and commercially, hence their currencies will stay in line for the most part. So expect the EUR to stay within [1.20-1.55] in the foreseeable future. But of course play the small trends and swings for short-term trading profits.

The strong Yen

November 30th, 2009
Japanese Yen

Japanese Yen

The Japanese recently made a new high, reaching levels unseen since 1995.

As a country depending a lot on finished good exports (Japan has no natural resources to export) since after World War II, the strength or weakness of its currency is a matter of national concern. When the Americans ruled and reorganized Japan in 1945, they created today’s Japanese Yen with a conversion rate of 360 Yen for one dollar.

Last Friday the Nippon currency reached 86.58, a fourteen years low and a long way from the initial rate set by the American. And this is getting closer to making an all time high.

This is bad news for the country which has suffered from deflation for the past decade. This is likely to continue with a stronger Yen making all imports cheaper. This is also bad news for local investors. On one hand the Japanese stock market never likes a strong Yen; on the other hand all financial derivatives based on getting cheap Yen financing including carry trades will suffer from a stronger Yen.

This situation illustrates the eternal debate about the merit and benefit of using a floating currency for a trading country. Japan let its currency floating completely during financial deregulation in the 80’s under pressure from the American. But the Big Brother in the North, China, has not fallen to similar pressure. And their exports are booming but their currency is not that strong.

A large part of China’s recent economic success and rise to the top of commercial leagues can be attributed to the weakness of the Renminbi. The Chinese engineered a massive devaluation of their currency in the 80’s and even though the Yuan is nowadays pegged at 6,83 after its recent appreciation, it is still a long way from its value of 1,50 in 1980.

The bottom line is that the currency policies employed by Japan and China in the past twenty years have been opposite in many respects, helping the gap shrink between these two countries. This simple notion can explain tremendous wealth creation in the Middle Kingdom with simultaneous wealth erosion in the Land of the Rising Sun.

As the Japanese officials are starting to show signs of concern after the latest Yen appreciation, it is going to be interesting to watch this next episode in the saga of Asian currencies.

The demise of the US dollar

October 29th, 2009

The theme of the weakening dollar is heralded in all news media.

This is nothing new to be honest and this was said years ago, even decades ago, until the dollar strengthened and then weakened ago.

Abandoning the dollar as the main international currency is a topic probably older than most currency traders nowadays. But years after years the dollar remains the main currency for forex trading, real goods trading, commodity trading in particular crude oil, currency reserves, etc. And if you travel and believe me I have traveled, and if you can only carry one currency with you, which one do you think it is going to be? Ok, ok sometimes the euro is more accepted such as in old French colonies in Africa, but this is by far the minority.

So why do people keep on writing thousands of pages and blogs about the demise of the dollar? The short answer I guess is people do not learn. Anyway the slightly longer answer is you need a currency to replace the dollar. It is not going to be the euro, because the euro is still a new currency (ten years old!) and even a large portion of Europeans do not like the euro, and it would be hard to convince the rest of the World to make it the reference currency. Yes one reason they do not like it is that it has induced concealed inflation.

You see, you need one currency to replace the dollar, and that currency has to be strong. The dollar will not be replaced by a smaller currency. Using a basket of currency to replace the dollar will never happen either. Why? Because a basket is not a currency in itself, it is an artificial creation with no relation to a real physical reality. The dollar is the dollar because it is backed by the power of the United States economy and population and army. Three not small backers. Baskets never have and never will be trusted and be able to compete with a true currency. Historically they have never worked. Just take the example of the predecessor of the euro, the ECU. It failed like all baskets, because the weaker elements in the basket make the basket fail.

So the point is only a currency can replace the dollar and it has to be strong. I just explained that the euro is not ready, far from it. What are the other strong currencies. The British Pound and Swiss French are way too small and local currencies to be even considered. The real serious contender is the Japanese Yen, and here again it cannot and will never replace the US dollar. First Japan is less than half the size of the US economy. Japan has no military. The Japanese Yen is not use as a currency for trading, unless one Japanese counterpart is involved in the transaction as buyer or seller.

So here we are, keep on printing pages after pages saying that crude oil will soon be traded in another currency like you have been saying for over ten years, and I am still waiting.

Wait, wait. So that is it? The truth is yes that is it. I hear someone say the Yuan. Please do I need to answer that? It is not even a freely traded currency please.

Summary: the dollar will remain the dominant world currency as long as there is no candidate for its replacement.

Is Quantitative Easing working?

August 30th, 2009

The US Government has embarked in unfamiliar territory in order to end the financial crisis: quantitative easing.

“Easing” just stands for making life easy for the banks, and indirectly for everyone, from an economic standpoint. “Quantitative” stands for quantity.

Ok, let us stop the bullshit for a minute. I find that one of the miracles of this new millennium is that a new widespread trend has emerged. The skill to rename old things with new names so that they seem to be completely novel and modern technologies, whereas there are simply rehashed old techniques. So to put it in plain English, quantitative easing simply means to print money.

This is certainly not new, and monarchs and emperors have used it since ancient time, any time they lacked the means to conduct the policies they wished to follow. Remember that Napoleon sold Louisiana (which was about one third of the United States by then) for a meager twenty million. So at least he had something to sell to finance his wars.

Earlier French Kings who did not have this luxury would routinely burn their Jewish bankers in the public square in order to cancel the royal debts and to get free assets in the process. Even earlier, since Antiquity the Royal Mint was the ideal medium to secretly change the composition of coins, hence creating many new coins from fewer old ones. When note bills became in use, it was much easier (literally and figuratively), as Government just had to go to the printing machine to get money.

Technically it is done differently nowadays thanks to the use of the digital money market and of sophisticated Central Bank operations. It is all a matter of orchestrating complicated monetary transactions through computers, networks and data center. Money is simply equivalent to how some bits are organized on some magnetic disks at some obscure data center.

Joke aside, financial markets have recovered nicely all over the World, not in small part because of the quantitative easing engineered from the United States. So far it seems to work.

Even though many non-believers doubt that this policy can work in the long term, it is clear that the recent economic maelstrom has lost is intensity and that a gentle global recovery is under way.

Following the Asian crisis in the late 1990s, a similar policy of quantitative easing was conducted by the Japanese Central Bank until 2006, adopting a zero interest rate policy, expanding banks’ balance sheets and purchasing long-term bonds. But this stimulus failed to materialize into any visible economic benefit, as banks continued to refuse to lend money even though that where overwhelmed with it.

This is what Keynes calls the liquidity trap, i.e. when interest rates are near zero, no more impetus can be gained from such monetary policy because interest rate cannot go below zero (usually). Fortunately the American and Japanese economies and cultures are radically different, so there is no need to believe that what occurred in the Land of the Rising Sun will repeat in America.

In particular their size and global economic importance differ, and one is a major exporting country whereas the other a major importing country. Also the US Government has adopted a wider policy than their Japanese counterparts.

It seems to work for now, but it is too early to tell the long-term consequence of financial easing in the USA. As his leading advocate, it is certainly one of the main arguments on how president Obama will be judged in the history books.

Regulating financial markets based on human nature

July 14th, 2009

Our new President Barack Obama is a man of action and reform.

After the blood bath taken by investors in nearly all market segments in recent history, one of Barack Obama’s efforts focusing on financial markets centers on his proposed “Consumer Financial Protection Agency”.

Interestingly the idea of this project is to apply the findings of behavioral finance to ensure transparency, simplicity and fairness to all market participants. The recent financial meltdown has demonstrated that some of our traditional human biases have exacerbated the risks taken by many individuals, leading to disastrous live-changing experiences for the most unfortunate.

Behavioral finance is a rather new field in finance. It was started as an independent methodology within finance about twenty years ago, even though some of its findings were known much earlier. But it took a long time for this “science of human behavior applied to finance” to become accepted amid academic circles. President Obama’s endorsement is a testimony of how much this modern approach has become mainstream.

This program falls under the nominee for heading the White House’s Office of Information and Regulatory Affairs, University of Chicago Professor Cass R. Sunstein. Professor Sunstein published “Nudge” last year with co-author Professor Richard H. Thaler, one of the leading scholars of behavioral finance. This very well received book describes how human behavior sometimes leads to suboptimal decisions in investing, health care, education and most venues of modern live.

This is a well known fact to all sales people who tend, consciously or not, to exploit these patterns in order to trigger a sale, sometimes using unfair or misleading tactics. For example risks that are hard to understand seem unlikely to occur (ask any mortgage-backed securities investor). Or it is believed that people providing more details tend to be honest (ask any Madoff investor).

Another hilarious example of how we human are dominated by such behavioral biases is that the same individuals who will omit investing in a 401k plan if they must opt in, will participate in it if they must opt out in order to cancel it. Even though the end result is the same, people behave differently if they need to act or not to act to achieve the identical final result.

It remains to be seen how effective this new regulatory approach will be. Wall Street is known to adjust to new rules faster than they get printed. But at least there is a general awareness of the issue of small biases leading to big losses in the Government, and maybe at some point in the public.

Status quo on rates in the euro zone

June 4th, 2009

The European Central Bank (ECB) has not changed its interest rates today, resisting pressure for a monetary gesture to stimulate a European economy that shows some early signs of recovering from the recession.

The ECB also said that it will make bond repurchase directly from the market from July to June 2010. The Bank of England is also observing a similar monetary status quo, keeping its intervention rate to 0.5%. Denmark announced a symbolic rate cut of 10 basis points to 1.55%.

The Bank of England said that it is continuing its program of acquisition of £125 billion ($143 billion) in Bonds to stem the recession.  ECB’s Chairman Jean-Claude Trichet announced Thursday the operating procedures of the operation for the European Union. The purchases, totaling €60 billion euros will be distributed throughout the euro area and it will be direct repurchases.

Considering that the risks to the economic outlook are broadly balanced, Trichet also believe that after a very weak first quarter, the economic contraction for the remainder of the year will be probably at less severe rates.

The Federal Reserve which, as the BoE and the Bank of Japan has cut rates below the threshold of 1% corresponding to the refinancing rate of the ECB is already examining the possibility of increasing rates to curb the enormous impact of its massive easing of the recent months.

The average interest rate on the planet in general has never been so low, and Central Banks will soon have to face the difficult issue of how to absorb the massive liquidity that has flown into the markets during the past year.

Today’s signs of slowing of the recession included unemployment numbers in the U.S. that fell for the third week in a row and retail sales in the euro zone that rose in April for the first time in five months, which bodes well for consumer spending despite the recession, even if this recovery is slow.

These good news led to today’s rally on Wall Street ( the Dow Jones was up 0.86%). The bull market continues, with its corollary of greenback weakness (EUR/USD=141.82).

Other good macroeconomic news were that housing  prices rose in May in Great Britain at their most sustained pace in six and a half years.

Long bond yields rose as the markets must absorb large offers of sovereign debt related to the various economic plans put in place around the world. This could later lead to fear that the rise in long rates may stifle the beginnings of the recovery.

Dollar weakness persists

June 1st, 2009

As mentioned in my previous post about the dollar, the current financial theme in the Forex market is dollar weakness.

As most bad economic news have already been priced into financial markets, and as these markets were created to anticipate, or speculate depending on whom you ask, the bullish market is continuing full steam at the start of June. The Dow Jones is up 211.11 points today.

The idea is that with so much Government intervention and liquidity creation by Central Banks globally, low interest rates and asset prices at much more affordable levels than they used to be, all is set for the next bull market.

This is not exactly a new bull market, but rather a current bull market as it started nearly three months ago. Only time will tell how powerful this rally is, but for now the bulls are dictating the direction of financial markets, with many new 6 months highs or lows reached today.

Rallying stock and bond markets, lower rates and liquidity injections make the dollar less attractive as an asset and this is the reason why a corollary of the current financial paradigm is dollar weakness.

Today’s rally was fueled by numbers showing that the US manufacturing sector was contracting at the lowest pace in recent history in addition to indications that commodity demand was strong in Asia.

The euro broke 1.42 in European time, to settle later around 141.60. The dollar was weak across the board and reached new 6 months intraday lows against most other currencies.

Based on the momentum theory, I forecast further dollar weakness in the near term.

Euro at a 2009 High on Dollar

May 23rd, 2009

Since the end of 2008, the Euro has traded in a range 1.25-1.40, moving back and forth.

In the pas few weeks, the Euro has rallied steadily and crossed 1.40 for the first time in 2009. What is also apparent is the correlation with the rally of the U.S. stock market.

The U.S. market has been rallying smoothly (with lower volatility) as of late, and for now momentum players are ruling the Euro. This is a standard type of trade with a mini trend started from a strong low (as the recent low is stronger than previous lows), plus the possibility to test a 6-month and a 9-month ranges, and to go all the way to the next magnet price of 1.50.

With respect to fundamental news, one reason for the rally is the recent decision by Standard & Poor’s to take a negative outlook on the triple-A rating of the U.K. This led to the belief that the triple-A rating of the U.S.A. could or should also be put on the same watch list.

Between you and me, this is ludicrous, as there is no better credit in the World than the U.S. Government. This is why it is called risk-free rate in Economics and Finance classes. Downgrading such rating is totally meaningless, as it just means all other credits should be shifted down as well. So this sounds more like an excuse to justify the rally than anything else, and confirms the momentum play theory.

In the other main currency pair, the Yen has also being very strong lately, confirming the scenario of overall medium-term U.S. dollar weakness, even though it corrected by late Friday. The dollar has also been weak versus the British Pound and the Swiss franc.

How is this dollar weakness playing in the bigger picture? For many months, part of the financial and forex business community has been concerned with the massive influx of liquidity created by World Central Banks, especially the Federal Reserve.

Printing money in times of crisis is not a new medicine, but the Obama’s administration is using it like there is no tomorrow. Creating money has always led to inflation since the first King of Antiquity started it. Only the future will tell us if this time is a different time. Or if this time there are strong enough counter forces such as a globalization induced deflationary wave to eradicate this mounting inflation.

For now, most economic indicators show inflation insouciance, such as the spread between the yield on the 10-year inflation-protected Treasury and the regular 10-year Treasury, which suggests inflation at 1.78%. But a number of smart money and well informed investors have been piling into Gold this year, betting that inflation will pop its ugly head at some point.

Best FOREX trading systems

April 30th, 2009

How to determine the best forex trading system(s)?

This is the 1 million dollars question as they say.

This is the first and most important question that you should ask yourself before starting an automated forex strategy. Because anything  else depends on how you make your judgment. Not knowing that this is the main question is a big error.

Very often novice traders or bot buyers will look at the return, the backtest return or the recent out of sample return. These numbers are very often the only thing that people look at.

The truth of the matter is that these are not the correct numbers to consider when evaluating forex trading systems.

Here is a back of the envelop list of some of the elements to make your choice:

  1. Currency diversity: does the system trade one or more currency pairs?
  2. Sharpe ratio: this is a much better statistics than return;
  3. Length of back-test: obviously the longer, the better;
  4. Length of out of sample: the longer the time since release, the better;
  5. General/Specific: is the system designed for specific market conditions?
  6. Drawdown: what is the worse case scenario?
  7. Reputation: who is the designer and what is his knowledge?

Looking at past return of recent returns is the most misleading idea. Past backtested returns are easy to manipulate. Recent returns are too short to have any statistical significance. Additionally leverage can also improve these apparent returns. Curve fitting weights is another way to play with returns.

More serious considerations used to find the best forex trading systems start with the Sharpe ratio. Whatever weakness one can find in the Sharpe ratio, it is without a doubt infinitely more potent than a return, which is just a floating number without an anchor whilst the Sharpe ratio is a return anchored by its  volatility.

The Sharpe ratio is just the beginning of a thorough analysis of any system. Drawdown is a complementary measure which is a conditional type of return, the worse return during the period under review. Stress testing and scenario analysis is a more sophisticated type of analysis.

What is the big difference between a backtested track record and a real money trading record? In the first case, a drawdown seems like the drawing of a  little roller-coaster on a sheet of paper. In the second case it feels like you are sitting NOW in the steepest descending part of a real roller-coaster.

The other elements in the list will help to strengthen your decision. Double up your caution and halve your optimism.  Many people are looking for the best trading system, but few find it. Ask your forex broker if they offer any trading system.

What is the most stable currency vs. US dollar?

April 22nd, 2009

Do you know what the most stable currency versus the USD is, in the past one year, five year or twenty years?

Of course if you are a currency trader or if you are from that country, it is easy for you to answer. It is a currency which has almost always stayed within a 1% band versus the greenback in the past 20 years.

It is the Hong Kong dollar.

Before I start, note that the Hong Kong Dollar (HKD) dollar is the currency of Hong Kong which is part of China, whilst the Chinese Yuan or Renminbi (RMB) is the currency of mainland China. They do not have the same value (but they are close) and do not follow the same fluctuations.

The HKD’s target rate set by the Hong Kong Monetary Authority has been 7.8 HKD/USD since 1983. And since then, this “pegged rate” has almost never moved away by more than a percent; very rarely was the rate below 7.72. At the time of writing, it is at 7.75. It is always less than 7.8, usually around 7.77.

So who cares?

I care and I hope you too if you are still reading. The point is that if you are here you must be interested in currencies. And what is so special about all pegs is that they are made to be broken. An unbroken peg for 26 years is certainly almost a miracle.

Hong Kong is a relatively small country. It is “bigger” now, indeed it is part of China, but in 1983 it was small and it was not on such friendly terms with its big brother in the North as it is now. No other country, small or big, has been able to maintain a USD peg that long. The Singapore dollar also had a loose peg, but it has been shaken by wild financial crises more than once.

Hong Kong also faced financial crises, and not just the recent one. Do you remember the so-called Asian financial crisis in 1997? Then all the currencies from the “Asian Dragons” collapsed: Singapore, Taiwan and Korea, but not the 4th Dragon, Hong Kong. Other lesser dragons such as Thailand, Indonesia saw their currencies lose as much as 75% of their value against the US dollar.

Malaysia, like Hong Kong, had pegged its currency. But the consequence of the financial meltdown was truly dramatic as the convertibility of the Malaysian Ringgit was suspended, the Prime Minister took drastic measures and sent his successor to jail under accusations of sodomy.

I take off my hat to the courage and determination of the HKMA during all these years. 1998 was particularly tough, as Soros and other hedge funds took positions against HKD, but it never broke. Certainly Hong Kong has and continues to have large currency reserves and abundant wealth, but without its political firmness, it could not have sustained all these emergencies.

If you are interested in making money using forex trading systems, please cross the HKD/USD pair from your list, as the chart is a near perfect flat line. Thank God, there are many other currencies to play with.