Forex Q&A With Ed Ponsi
New Year's Day is more than just the first day of a new year; it's also the day when everyone's profit and loss statement for the past year is erased. No matter how the markets treated you in 2007, we all reset to zero on January 1st. Congratulations to those of you who had a profitable year; I received several emails from students who had tremendous breakthroughs, nice work! Even if you didn't have a great year, consider this – you've gained valuable experience, a necessary component to long-term success. Let's get to your questions…
Q) Hi Ed, how does one trade the Canadian Dollar against the Euro?
Ed Ponsi) Aye Carumba! The recent activity in the EUR/CAD currency pair reminds me of a roller coaster I rode once at Universal Studios, roaring higher and plunging lower. The funny thing is, for a long time this pair was fairly quiet, and range bound trading was the norm. First let's look at the fundamental picture; commodities are rallying again, with gold trading well above $800 and oil closing in on $100, and the Canadian Dollar is likely to benefit if this rally continues. Meanwhile, growth is strong in Europe, the ECB has refrained from cutting interest rates, and ECB head Jean Claude Trichet still sounds very hawkish, with his rhetoric focused squarely on inflation. A slowdown in the U.S. is threatening Canadian growth, while a worsening economy in the U.K. does not bode well for Europe. Fundamentally, it's a close call; neither side seems to have the upper hand.
The daily chart of EUR/CAD shows a sharp rise followed by a pullback to the 50% Fibonacci retracement level. The pair has climbed about 250 pips in three days since reaching Fibonacci support. (see figure 1).
Figure 1: EUR/CAD bounces off of a 50% Fibonacci retracement. Source: Saxo Bank
Before I get too excited about the prospect of trading the Euro vs. the Canadian Dollar, I have to look at the longer-term direction of the pair, or lack thereof. It's not surprising that when both currencies in a pair present a similar fundamental picture, the technical picture becomes muddled. I'd much rather match up a strong currency vs. a weak one, a scenario that is more likely to present an opportunity to capitalize on a directional trend. I would be very cautious about placing a trend trade on this pair, because it has no clear long-term direction. In other words, be less aggressive with your exit strategies, as the current trending behavior does not fit the profile of this currency pair (see figure 2).
Figure 2: The past five years of EUR/CAD reveal a lack of direction Source: Saxo Bank
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Q) Hi Ed, your analysis has been right on and helpful in my trading. Can you briefly explain Average True Range (ATR)?
Ed Ponsi) Thank you for your question. You probably wouldn't trade shares of Google the same way you trade shares of General Electric, because Google is the more volatile of those two stocks. You'd probably use wider stops and exits while trading Google than you would on most other stocks. But how can we objectively measure the volatility of the stocks or currencies that we trade?
Average True Range, or ATR, is a useful indicator for measuring volatility in currencies, stocks, and other trading instruments. It depicts average movement for the period of time measured, and the normal default setting is 14 periods. For example, this daily chart of EUR/GBP shows its current volatility - less than 0.0050, which translates to just under fifty pips per day – based on the last 14 trading days (see figure 3).
Figure 3: EUR/GBP's ATR reading is under 50 pips per day. Source: Saxo Bank
An average movement of fifty pips per day is pretty quiet for a currency pair, kind of like watching paint dry. Still, some traders prefer a slower-moving instrument. Compare this to the activity in the GBP/JPY currency pair, which has a current ATR of 2.15, or 215 pips per day, based on the past 14 days. This pair has calmed considerably since last month, when the daily range briefly climbed above 400 pips per day (see figure 4).
Figure 4: ATR demonstrates that GBP/JPY is extremely volatile. Source: Saxo Bank
Based on current ATR readings, it would be fair to say that GBP/JPY possesses more than four times the volatility of EUR/GBP. This is not to say that one should or should not trade either of these currency pairs; all traders are going to gravitate toward their own personal comfort zone and trade the instrument that suits them best. ATR is a great tool to help determine if a particular currency pair is your "cup of tea".
Q) Regarding the last paragraph of your last week's article, isn't that market manipulation and isn't that unethical and illegal? (The question deals with market rumors; see last week's newsletter for more info on this topic).
Ed Ponsi) Thank you for your email, I hope you're enjoying the holidays. To answer your questions, a) yes it is a form of market manipulation, though not as blatant as many other forms (such as mutual fund traders trying to jam a stock higher on the last day of a quarter to improve their performance figures, or a group of stock traders trying to force a stock to break out) b) yes it is unethical and c) it is probably illegal, but a rumor could represent an opinion as opposed to declaration of fact. Plus, how do you prove in a court of law where a rumor initially started?
I certainly don't condone this type of behavior, but the fact that it is unethical changes nothing; this is the real market and as Walter Cronkite used to say, "That's the way it is". Rumors are even more rampant in the stock market, as individual stocks are relatively easy to manipulate compared to currencies. Whenever there are large sums of money involved, there is the potential for attempted manipulation. Better to know the truth and be prepared than to attempt to trade an idealized version of the markets that exists only in our minds. At least in the world of forex trading, the tremendous size and liquidity of the market makes any kind of manipulation extremely difficult.
I am not shy about telling folks the way things really are, because they need to know what they're up against; we need to trade with our eyes wide open. Besides, if you see the market moving on a rumor at a time when you know that rumor is unlikely to be a true fact, this might present an opportunity to 'fade' or trade against the move caused by the rumor. The fact that we don't like this type of activity will not make it go away, so it is better to understand it and be prepared for it than to simply ignore it.
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