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Awesome Aussie
The Australian Dollar continues its march to parity, hitting a 25 year high against the U.S. Dollar last week. All of the reasons for Aussie's strength, listed in earlier articles such as Aussie Ascending and Thunder from Down Under are still valid, and AUD/USD breached .9700 as the commodities rally continues unabated. Meanwhile, the greenback is stuck in reverse, as the Freddy Mac and Fannie Mae debacle is pressuring the U.S. currency. Just as we saw earlier this year, the Aussie has formed an ascending triangle on the weekly chart, a bullish pattern that portends a likely move higher. AUD/USD is setting yet another 25 year high as I write this on July 14, after pulling back just a handful of pips from last week's record (see figure 1).
Figure 1: AUD/USD forms another ascending triangle on the weekly chart. Source: Saxo Bank
The USD is in a no win situation; if the U.S. government had failed to back Freddy and Fannie, traders would have lost confidence in the dollar. On the other hand, if a bailout is engineered or if liquidity is injected to prevent another credit crunch, the dollar is likely to suffer as well. Right now, a bailout appears likely, with the U.S. Treasury buying shares of the companies and increasing a line of credit extended to them. The Treasury has no choice but to say, "Put it on my tab," which will almost certainly result in larger budget deficits, more borrowing, and – you guessed it – a weaker U.S. Dollar. Talk about a no win situation!
The greenback is already taking a pounding in anticipation of this weakness, and the recent USD rally that was so heavily hyped has turned into yet another dollar disappointment. The Euro – U.S. Dollar currency pair (EUR/USD) looks as if it's getting ready to take another run at 1.6000, trading less than one hundred pips away from the figure. And just like AUD/USD, the pair has formed that familiar bullish ascending triangle on the weekly chart. This by no means guarantees that the exchange rate will continue to rise, and there will almost surely be some resistance at 1.6000, but the technical and fundamental aspects of this currency pair seem to be in harmony right now, and the strong trend that has been intact for so long shows no sign of ending (see figure 2).
Figure 2: EUR/USD also forms an ascending triangle on the weekly chart. Source: Saxo Bank
Question of the Week
Q) I have a question regarding Pivot Points. I get the feeling that you do not really consider them an effective tool. Is this true? Can you make money trading pivot points or are they just so much technical baloney created by desperate traders? Would you trade them yourself and if the answer is yes, how exactly would you use them? Also, because of their popularity, would you consider them (like Fibonacci levels) self-fulfilling prophesies? Thanks for your attention.
Ed Ponsi) That's a great question! It's true that I don't put a lot of emphasis on pivot points, but that doesn't necessarily mean that they won't work. There are many trading tools out there, so many that nobody could possibly use them all, but that doesn't mean they are not valid. Just what are pivot points? They are artificial support and resistance levels, created from a calculation instead of from actual levels that proved to be turning points in the past. The calculation for the initial pivot point is the previous day's High Price plus Low Price plus Closing Price (H + L + C) divided by 3 = Pivot Point (PP). Then a series of calculations are applied to the Pivot Point to create Support Levels 1, 2, and 3 (S1, S2, S3) and Resistance Levels 1, 2, and 3 (R1, R2, R3).
But will Pivot Point strategies work? They certainly can, as we see in the 15-minute chart of the Euro – Swiss Franc (EUR/CHF) currency pair below, which depicts the price bouncing off of the Resistance 2 support level on the lower right side of the chart (see figure 3).
Figure 3: EUR/CHF bounces off of R2 Pivot Point on the 15 minute chart. Source: Saxo Bank
As you mentioned, Pivot Points create a self-fulfilling prophecy, just like Fibonacci. The self-fulfilling nature of this calculation requires that other traders use it, and as more traders adopt it, the results should improve. For example, Pivot Points are widely used by index futures traders, so I would expect them to work well when used in that market. They are not as widely used in the currency markets, so I would expect pivot points to be less effective for Forex traders.
One of the problems with Pivot Points is that part of the initial equation is based on the closing price (H + L + C). The closing price does not present a problem in a market that has a definite standard closing time, but remember Forex is a twenty-four hour market. While many Forex traders consider 5 pm New York time to be the opening (and closing) time of the currency market, this is not universally accepted. So, a trader who considers, say, midnight London time as the opening and closing time of day will have a different closing price than a trader who uses 5 pm New York time. Since these two traders have different closing times, they might have widely different closing prices – meaning that the result of the Pivot Point calculation will be different for each of them. This is a major flaw, as it will not be possible to create an effective self fulfilling prophecy if different traders are getting differing results from their calculations.
While Pivot Points will work well for index futures, Forex traders have their own calculation for creating artificial support and resistance level called Fibonacci retracements. The Fibonacci calculation includes a high price and a low price, but there is no need to enter a closing price. This makes Fibonacci perfect for the Forex market, which does not have a universally accepted closing time. Fibonacci is also a big part of the "culture" of Forex trading; it is widely used by both individual and institutional traders.
Here's a fine example; on the daily chart, we see the U.S. Dollar – Swiss Franc (USD/CHF) currency pair streaking downward during the first quarter of 2008. When the downtrend reverses, how high will it go? Not only did the pair peak at the 50% Fibonacci retracement, it bounced off of it numerous times, giving traders multiple opportunities to sell short (see figure 4).
Figure 4: USD/CHF finds resistance at the 50% Fib retracement. Source: Saxo Bank
Coincidence? Maybe, but if enough traders place sell orders at the 50% Fib, the resulting selling pressure will repel the price when it reaches that point –once again demonstrating the self fulfilling nature of Fibonacci.
Have a question about Forex trading? Send an email to eponsi@tradingacademy.com and we may use your question in an upcoming newsletter. Until next time, best of luck to you in trading.
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Ed Ponsi is a globally recognized name as a lecturer and teacher and is the former Chief Trading Instructor for Forex Capital Markets. An experienced professional trader and money manager, Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ed has appeared on CNBC, CNN International and TheStreet.com, and has recently written his first book for Wiley Finance, "Forex Patterns and Probabilities" (which you can purchase through