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Trader's Tip
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Although traders have come up with a number of complex strategies to trade currencies and other markets, I like to take the KISS - Keep It Simple, Stupid - approach to analysis.
- Darrell Jobman |
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Today's Featured Article
No one can be sure how the latest Federal Reserve action on short-term interest rates or Treasury bailout funding or the latest economic statistics will play out in the currency markets, but chart analysis can suggest some good short-term trades before they become obvious to everyone else. The U.S. dollar is a good example, bouncing higher after nearly everyone had become convinced that the inflation of the money supply would lead to higher prices and a weakening dollar to get the U.S. economy out of its debt mess.
The nice thing about currencies is that you can analyze them from several angles. With wheat or gold or most other markets,
intermarket analysis can help you evaluate the influence of interrelated markets on each other, but it gets down to just the wheat chart to make an entry/exit decision.
With currencies, however, you can look at the U.S. dollar priced in terms of another currency or you can look at the other currency priced in dollar terms. You can evaluate currency pairs in the cash market, or you can measure the value of major currencies against the U.S. dollar in the futures market. Analyzing currencies and charts in various ways can help you see where the strength or weakness lies.
Although traders have come up with a number of complex strategies to trade currencies and other markets, I like to take the KISS - Keep It Simple, Stupid - approach to analysis, keeping in mind that analysis and trading involve two different skill sets. As an analyst, here is my process:
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Long-term traditional chart analysis
What is the big picture? What is the current market environment? For currencies, I like to start with the U.S. Dollar Index although the market actually being traded may be the euro, British pound or some other foreign currency. As the world's major currency, the dollar provides a pretty good gauge of the influences on the Forex market.
Go here to see complimentary recent forecasts for the dollar.
As you are probably aware, the dollar has been in an overall downtrend since 2001-2002, and conditions would seem to favor continuing down that path. Zooming in to a chart for the last year (below), the dollar has been sinking since March but has popped back up in the last week (green circle). Although the steep downtrend line has been penetrated, the downtrend is still intact.
Without attempting to get into the debate about the inflation vs. deflation undercurrents that may be affecting the dollar's value, the key points for traditional chart analysis are indicated by the red arrows for resistance and blue arrows for support. These are areas to watch closely for potentially volatile activity if prices approach them.
 If you cannot view the example chart, go here.
Intermarket analysis
With a longer-term down trending pattern well-established, where are potential trades? Many traders have too narrow a focus, looking only to see if prices on the chart they are watching are likely to go up or down. They should be looking in one other direction: Sideways. What is happening in other markets related to the market they are trading? That is particularly true in today's global markets and especially in currencies.
Intermarket analysis is the basis of
VantagePoint Intermarket Analysis Software
, which uses neural networks to determine the 25 markets that have the most influence on a target market and then produces intermarket data to develop indicators that can provide short-term forecasts of price direction based on the influence of interrelated markets. You could use VantagePoint to create a complicated strategy, but I prefer a simple method using a combination of only three simple criteria to buy:
- Predicted Neural Index at 1.00.
- Predicted medium-term exponential moving average (EMA) of typical prices above the actual medium-term simple moving average (SMA) of the close.
- Predicted moving average difference lines angled upward.
And three simple criteria to sell:
- Predicted Neural Index at 0.00.
- Predicted medium-term EMA of typical prices below the actual medium-term SMA of the close.
- Predicted moving average difference lines angled downward.
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Here is how those indicators look on a current chart of the U.S. Dollar Index:
 If you cannot view the example chart, go here.
The Predicted Neural Index is a proprietary indicator that compares today's actual three-day moving average with a predicted three-day moving average to indicate whether the market will be higher (reading of 1.00) or lower (reading of 0.00) over the next two days (gray line on chart below).
Crossovers of the medium-term moving averages point to changes in direction. When the predicted medium-term EMA (blue line) is below the actual medium-term SMA (black line), you should be short; when the blue line is above the black line, you should be long.
The predicted moving average differences (maroon and green lines) at the bottom of the chart show the amount that the predicted EMA of typical prices (average of high, low and close) is above or below the actual SMA of the close. This is a visual indication of the strength or weakness of the moving average trend.
The red arrow indicates where the combination of indicators came together to indicate the beginning of a potential downtrend. I also like to look at the major candlestick patterns (dojis, engulfing candles, etc.) for further confirmation - in this case, a doji and a series of black candles also suggested weakness.
The blue arrows on the chart highlight those times when the neural index shifted from 0.00 to 1.00 and/or the angle of the moving average difference lines changed and provided an alert that the downtrend could end. But careful placement of stops above previous highs should have kept a short trader in the downtrend until the market reached the low on the long-term chart in the 78.50 vicinity.
The market has bounced off that low and indicated a trend reversal to the upside with the neural index at 1.00, a moving average crossover and the moving average difference lines and predicted EMA (blue line) all angling upward (green arrows).
Will the uptrend last a week or a month? I don't know. We can't conclude from this chart that the U.S. dollar has made a long-term bottom or that it will gain strength for a long time. Just like weather forecasts, the shorter term the price forecast, the more reliable it is. VantagePoint indicators are only providing short-term clues, but all an active trader needs is an early alert to get into a position before the crowd and then manage that position carefully.
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About the Author
| Darrell Jobman
has been writing about financial markets for more than 35 years, covering all aspects of the trading industry. A decorated Vietnam War veteran; he was a newspaper farm editor and editor of several agricultural publications before becoming an editor of Futures Magazine for more than 15 years. He has written and/or edited more than a dozen books on trading including The Handbook for Technical Analysis. His passion is helping others succeed by learning the "dos and don'ts" of trading. |
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