If I were to attempt to choose a single word to best describe the overall market action taking place in the currencies these past few months I would have to pick the word "volatile." It has seemed almost commonplace of late to observe for instance the Euro rallying sharply one day only to see it reverse to the downside the very next day, giving back everything it gained from the previous session.
Many traders observing the initial powerful rally have come pouring onto the long side only to watch in dismay as their newly instituted positions are immediately driven into the red. Some of the more aggressive will have already reversed and gone to the short side only to see the infernal thing turn right back around and rally again blowing them out of the water in the process.
For those who might be novices and unfamiliar with such a thing, it is referred to as getting "whipsawed." Take it from a guy who has had it happen to him plenty of times throughout his trading career, it is one of the most frustrating things that can happen to a trader or shorter term investor. As a long time commodity trader, I can tell you one thing for certain: Whenever this sort of volatile "whipsaw" action is the norm, get ready for something of significance to occur.
Before speaking to that directly, take a look at the following chart of the Euro as an example and let's observe a few things together. First of all, please notice the parallel white lines. Since mid-May the price action in the Euro has been pretty much confined between these two lines with only a few exceptions.
We can first of all then determine that the Euro is in a "chop" or range trading mode in which the upper boundary is near the 1.2380 region and the lower boundary near 1.20 or so. It is certainly not exhibiting any definite trend but is rather ricocheting off of these boundaries.
That brings us to my first point: Range trading markets are typically conducive to whip sawing traders. The reason for this is that the vast majority of speculators tend to be more or less trend followers who gear their approach to the markets based on moving average crossovers or settlements that close above certain designated moving averages.
In a range trading market, just about the time that happens and a buy or sell signal is generated, the market will tend to bounce away from either the upper or lower boundary of the trading range, sticking the would-be trend follower with an almost immediate loss. Some will have their stops elected and simply get knocked out of their position. Others will have a reverse stop in place which will simply take the other side of the market and attempt to go with the flow.
You can see from the above chart that in many cases this strategy would have stuck any traders attempting to implement it with losses going in both directions. Talk about watching your trading account implode. You go long and the market sells off. You lose money. You then decide to reverse and go short in the hopes of quickly making it all back plus some. The market rallies and you lose again. You then decide your original strategy was the correct one so you now come back in on the long side once again. Two days later the market has a huge down day and out you go again. That's three different positions all of which have lost money. About that time you either swear you will never have anything to do with currencies again or you are out of money anyway and thus your would-be trading career comes to a rather inglorious end.
To illustrate this let's return to our Euro chart although this time we will insert a window which depicts one of the most basic trend following systems that is still in use: a simple crossover of a 10 Day Moving Average and a 20 Day Moving Average. A buy signal is given when the 10 DMA turns up and crosses over the 20 DMA from beneath. A sell signal is generated when the 10 DMA turns down and crosses over the 20 DMA from above.
It should be noted here that there are far more exotic and complex trend trading systems in use these days as hedge funds become more and more sophisticated and computer power becomes less expensive. Still, at the heart of many trend following systems, moving averages and their crossovers play an integral part. Thus, I feel completely justified in using the simple and basic approach that will be demonstrated here to illustrate my point.
Note on the chart of the Euro itself that there are two different colored arrows and that each colored arrow is pointing either up or down. If you notice the moving average insert above the actual price data, you will see that these arrows correspond to crossovers of the 10 DMA and the 20 DMA. A blue arrow pointing upward is a buy signal given when the 10 DMA has crossed over and above the 20 DMA. A black arrow pointing downward is a sell signal which occurs when the 10 DMA has crossed over and beneath the 20 DMA.
Upon close examination of the chart, you will see that in most cases, just about the time that the trend following system would have put you into a trade, either long or short, the market would soon after reverse. If it did not, by the time you actually got the signal to lift your trade, the exit point would have forced you to cough up any money you might have actually made. Regardless, your trading account would look like Helm's Deep after it had encountered the army of Uruk-Hai.
Some of you out there who might happen to be reading this are probably shaking your head up and down right now and muttering under your breath, "Yep, that's exactly what happened to me"! Well, if it has you might take some consolation in the fact that most of the giant hedge funds are not faring much better this year.
I have read reports where the estimates are that many of these funds are down 20% or better this year alone. Some are reported to be down as much as 40%! That is astounding. The reason is that they too are getting whipsawed and are constantly instituting new positions only to have those positions move against them. As soon as they reverse (hedge funds show no particular preference for either the long or the short end of most markets they trade and are apt to be on either side) the market catches them flatfooted as well and they take a hit.
What this nearly constant whipsawing is beginning to produce is what might be termed a case of "triggeritous fingerous" (itchy trigger finger). The guys manning the trading desks of many of these firms have been burned so badly this year that they are ready to run at the drop of a hat. All it takes is the stroke of one computer key or the "Enter" button of a keyboard and literally billions of dollars move from one side of the market to the other. Voila! We have our wild swings which get only wilder as more and more of the bigger players get antsy and nervous.
This brings me to what I would particularly like to focus on in this essay. I have fielded more than a fair share of questions of late with the common theme of: "Why is everything so wacky and jumpy out there?" My answer is that I believe that what lies behind this incessant schizophrenic price behavior we are witnessing is the lack of conviction among many of the major participants. Simply put, a great number of people are becoming increasingly confused as to what is actually taking place out there. Why?
Their fundamental analysis is being contradicted by technical signals on an almost regular basis. It is this contradiction which is producing the uncertainty in the mind of many of the major players. Having carefully formulated a fundamental approach to the market, these players enter their positions which almost immediately seem to go sour. Let this happen often enough and sooner or later even the best traders begin to doubt their own judgment at times. Out of fear that they might be wrong, they are ready to quickly abandon their positions and even reverse them. Instead of trading from a position of confident strength, they become jumpy and nervous and find themselves flip flopping back and forth between the long side of the market and the short side.
Some of you who are reading this might not believe that this is possible, but I will assure you as a long time trader, this is something that every trader WILL experience at some point in their trading career should they last long enough. Price action that does not confirm your judgment can be very unsettling especially after long hours of meticulous research.
Once you become convinced that you are right and yet watch time after time as the market moves against you, it does indeed tend to rattle your confidence. You begin to make mistakes and operate out of fear. Once that occurs, it seems as if everything begins to snowball and things go from bad to worse.
The question that should now present itself to a thinking individual is exactly why this seems to be occurring (i.e. what is causing the technical signals that are conflicting with the fundamental view of many of the major players and creating this volatility?).
This trader believes that it is official sector intervention into the market place that is the blame, especially the Exchange Stabilization Fund (ESF) as it moves to prop up the dollar on an almost regular basis.
Look at it this way: The financial authorities who have hatched their plans in secret, want nothing else but to see those plans implemented with as few impediments as possible. Enter the speculators and the mega hedge funds. This group is the bane of central planners since their actions tend to exacerbate price moves especially in the Forex arena. What the Central Planners such as the Fed or the Bank of Japan for instance want to avoid, is allowing these hedge funds to concentrate their firepower on one side on the market and then pile on more and more and more positions.
Once the specs can generate sufficient price movement to begin a trend in one direction, the trend begins to feed on itself as the momentum begins to build which draws more specs into the market on that same side and so on and so on and so on. Before long the price move begins to accelerate sharply and take on a life of its own.
Financial authorities despise this sort of thing since it wrecks havoc on their schemes. They will counterattack through intervention, either verbal or actual, and attempt to disrupt the process resulting from the action of the specs. We have all seen for instance how the Bank of Japan counterattacked the specs in February this year. That is something that occurs often enough that seasoned Forex traders are well acquainted with it.
However, I submit that these financial elites have either stumbled upon or ingeniously devised a new weapon in their arsenal and that weapon is what is currently being used right now. The newest idea is to keep the hedge funds off balance, keep them guessing, and thus prevent them from amassing their financial might on one side of the market or the other and driving it into a solid trend.
Once the hedge funds sense weakness in a currency - let's take the dollar for instance - they will attack it mercilessly and pummel it into near oblivion if given half the chance. If the Fed, in the case of the dollar, can keep the funds guessing and on their toes, then the confidence of the big specs that allows them to pile on huge amounts of positions will be absent. They will tend to tread more cautiously and be much more prone to snatch at profits quickly and even reverse if occasion calls for it.
Let's consider how this might apply to the U. S. Dollar. From a fundamental perspective, the dollar is for all practical purposes dead in the water. Given the gargantuan trade deficits of the U. S. and a current account deficit that shows no sign of moving back towards balance, the dollar MUST weaken further. When the federal budget deficit is added to the mix, the necessity for a weaker dollar becomes even more pressing. That is an indisputable fact.
Let me interject something briefly here before proceeding for the sake of those who continue to give heed to some well respected individuals who have been advocating the "synthetic short dollar" theory. This theory is so full of holes and misconceptions that it is beneath refuting by anyone who has the slightest understanding of how the currency markets operate.
Now back to the main subject at hand.The truth is that those who have correctly sized up the dollar know that it is a disaster waiting to occur. Fundamentally, the dollar should have broken down some time ago, especially after last month's release of the stunning trade deficit and the stinker of a jobs report. Yet what did it do? The days of both releases it sold off sharply as could have been expected. Looking at the chart of the dollar below, you can see the sell off marked by the RED down arrows.
The first one occurred on August 8, when the jobs number for July was released. It fell 1.3 cents which is a huge move. The next sell off occurred a week later on August 13, when the monthly trade deficit of $55.8 billion for the month of June was announced.
You can see from looking at the chart that this time the dollar was clocked for almost an entire cent. Instead of permitting the Forex market to drive the dollar further down however, the ESF stepped in and goosed it back up. Notice that within two week's time, the entire drop had disappeared and the market was trading back above the level prior to the releases. It was like the trade deficit numbers and the jobs numbers never existed!
Given the seriousness of both numbers, there WAS ABSOLUTELY NO FUNDAMENTAL REASON for the dollar to rally whatsoever. It was not oversold by any measure. Yet rally it did and with sufficient strength to force the hedge funds who had properly piled on the short side to scramble and cover. They were effectively squeezed out as the short term indicators told them to get out of their newly instituted short positions.
Do you see how the game is being played by the Fed? Had they not intervened, downside momentum would have built up and the dollar would have quickly broken through horizontal support near the 87.20 region. That would have created a rapid meltdown of the dollar as the avalanche of sell stops under the market would have set off a cascade effect initiating a sustained TRENDING move, exactly the thing the specs want to see and exactly the thing that the Fed does not want to see!
So what does the Fed do? They intervene with enough effort to hold the technical support level which results in the shorter term players buying back their shorts. That in turn trips the oscillators over and generates the buy signals on the black boxes of the hedge funds who then lemming-like cough up all those new shorts. But then notice what the dollar does once that process is finished - it turns right back around to the downside once again. Is it any wonder that many of these hedge funds are showing negative returns this year with this kind of nonsense taking place? Can you see how this strategy would tend to keep the hedge funds from piling on and as far as the Fed is concerned?
What is critical and bears mentioning here, however, is that although this strategy by the authorities has seemingly been effective over the course of the last few months, it is ultimately doomed to failure. While to their credit they have managed to stymie the hedge funds for the time being by creating this maddening whipsaw action in the currency markets, they might as well be spitting into the eye of a hurricane as to prevent what is coming the way of the dollar.
Funny thing about the eye of a hurricane- you can actually walk into it and it is as calm as a normal sunny day. If you look up you can even see blue sky in many cases. If you get the urge to spit, you can do that to your heart's content. But sooner or later the wall of the eye will cross the distance between you and it and in that moment, the full force and fury of the storm will immediately engulf you, flinging you about as if you were nothing but a cheap rag doll.
The short term technical signals that the boys at the ESF have managed to create will work for now, but the longer the fundamental case continues to build for a weaker dollar and that dollar refuses to go down, the stronger the force of the wind in the storm that is going to descend upon the Fed and its gang of arrogant elites. They might know what is inevitable; they might not.
I am more inclined to think that in their heady power plays of late, they have become so enraptured with their own ability to affect short term changes in market direction that they have managed to deceive themselves into thinking that they can handle anything that the hedge funds want to throw their way. Guess what? Their education is going to be one that they are never going to forget.
When the fundamentals become so overwhelming that they cannot be ignored any longer, Fed or no Fed, ESF or no ESF, the sums of money that are going to be hurled at the U.S. dollar are going to leave the financial planners reeling in bewilderment.
Which now leads me to my final point - range trading markets eventually break out one way or the other. They do not bee-bop around indefinitely and they break out in the direction that the fundamentals dictate they should break out in.
Typically, what I have found over the years is that the more volatile a market is becoming, the more likely is the chance that something is afoot which will soon impact that market and send it careening off in one direction or the other to start a powerful trend.
Given what we are witnessing of late, I believe we are rapidly approaching the zero hour for the dollar. It may not take place immediately but I do believe that it will take place before the next year is out. The effect on the dollar at that time will be devastating.
All I can say is do you own gold? If not, you had better get some while you can!
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