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The Four Horsemen, the S&P, and the Yen
One of the recurring themes of 2007 was the close correlation between the Japanese Yen and world equities markets. Well, that relationship is alive and well in 2008, as the recent plunge in stock prices has been accompanied by a massive Yen rally. It's no coincidence that a break of major support on the S&P 500 was preceded by a major breakdown in the Great Britain Pound – Japanese Yen (GBP/JPY) currency pair. Many of those stocks were purchased with the proceeds of carry trades, and now that those stocks are being sold off, the carry trades are being unwound. The rout is on in GBP/JPY, as we can see by the plunge on the weekly chart (see figure 1).
Figure 1: Head and shoulders break in GBP/JPY. Source: Saxo Bank
The ominous drop in GBP/JPY could be a precursor to the next move in the equity markets, but there is one currency pair that tracks the stock market even more closely. The Euro – Japanese Yen currency pair (EUR/JPY) has created a huge topping formation, and may be the next to go (see figure 2).
Figure 2: Massive top forming in EUR/JPY. Source: Saxo Bank
Now compare the action in EUR/JPY to the recent damage in the weekly S&P 500 chart; we see a similar topping formation (see figure 3).
Figure 3: S&P 500 weekly chart looks eerily similar to EUR/JPY. Source: Stockcharts.com
One factor to observe when following equity markets is the 'leading stock' phenomenon, where the price behavior of certain stocks can lead entire sectors. These leading stocks are often referred to as "The Generals" or, when specifically referring to tech stocks, "The Four Horsemen". When I started trading, the Four Horsemen were Microsoft, Intel, Cisco, and Dell. Now that those stocks have matured, four new ones have taken their place – Google, Amazon, Apple, and Research in Motion, better known as RIMM. These days, RIMM is looking grim, as evidenced by the weekly chart (see figure 4).
Figure 4: RIMM chart shows a double top, and has fallen far from recent highs. Source: Stockcharts.com
Even more ominous is the weekly chart of that favorite stock of TV prognosticators everywhere, Google. Notice the double top formation again, as the stock comes to rest near $600 per share (see figure 5).
Figure 5: Google stock reaches a 3-month low, as the double top forms. Source: Stockcharts.com
I'll spare you the charts of Apple and Amazon, suffice to say that they both sport a double top and look only slightly better than RIMM and GOOG. With leaders like these, US stocks could be in big trouble – and if that turns out to be true, the Japanese Yen should be the big winner.
Free Special Event in Washington! Chris Koomey, Scott Trello, and everybody at the brand new Online Trading Academy Washington, DC office would like to invite you to a special Forex seminar and book signing event on February 29. I'll be speaking about the Forex market and answering your questions, and my new book "Forex Patterns and Probabilities" will be available at a special discount price. Who knows, maybe Mitt, Hillary, Rudy, and Barack will show up! I hope to see you there.
Questions of the Week
Q) Hi Ed, I like your newsletter very much. How the Forex market will react if fed cuts the rate by 50 basis point by end of the month. Is it already priced in? Thanks much, Nilesh
Ed Ponsi) Hi Nilesh, good to hear from you! I believe that a 50 basis point rate cut is priced into the market right now, and there will be a tremendous level of disappointment if the Fed does anything less. In fact, the situation is becoming so dire that some analysts are talking about a potential 75 basis point Fed funds rate cut! What do I mean by a dire situation? Think about all of the "safe money" tied up in AAA rated bonds. When the stocks of companies that insure those bonds, like AMBAC and MBIA, are being destroyed, one must ask this question – are those bonds really insured if the very existence of the insurer is being called into question? On Thursday, AMBAC dropped 51 percent and MBIA fell 38 percent after Moody's and S&P said that they are reviewing the rankings those companies depend on to sell bond insurance. As if that weren't bad enough, Fitch cut AMBAC's rating from AAA to AA on Friday, and took action on 137,000 bonds insured by AMBAC, the vast majority of which are municipal bonds. This is just the latest in a series of crises faced by the financial markets related to the subprime mess.
I think Bernanke will give the market 50 basis points, and the market also believes this, but will it be enough? The current action in the US stock markets tells us that traders believe Bernanke and the Fed are behind the curve. So what will move the markets next? Any comments from the Fed will be closely scrutinized for clues as to their next move, which could be an inter-meeting rate cut. Bernanke has been dealt a tough hand here, and traders need to be reassured that the Fed is ready and willing to throw them a lifeline.
Q) Hi Ed, I always make it a point to read all your articles as I find them very educational and practical. There are so many so called "Gurus" who make wild promises on turning anyone into a millionaire; it is rather refreshing to read your down to earth articles. I have one simple question: kindly recommend what indicators to use for determining trend and which currency pairs should a day trader trade. Please keep up your good work on Q & A sessions.
Ed Ponsi) Thank you for your questions. Regarding the first part of your question, please refer to this earlier newsletter, where we covered several different methods of trend recognition, including moving averages and the ADX indicator. The question of which pairs to trade is one that I hear frequently; I really want students to begin trading on the majors, which are the currency pairs that have the tightest spreads. For a day trader, the spread is a formidable obstacle to profitability, so any short term trade must take both the spread and the volatility of the currency pair into consideration. EUR/USD is the most liquid pair in the world, and has the tightest spread of all the currency pairs, so this is a good place to start. Once you get used to trading EUR/USD, you may want to try something a little more volatile; GBP/USD fits this description nicely, it tends to correlate well with EUR/USD (meaning that it moves in a similar fashion), only its moves are a little more exaggerated. Next, you might want to branch out into the USD/JPY currency pair. The Yen "goes its own way" and is heavily influenced by price action in the stock market. Once you've grown comfortable with these majors, you may want to branch out into the "crosses", currency pairs that do not contain the US Dollar. The EUR/JPY pair is a good example of a cross that is popular among currency day traders. Just be careful regarding the spread; the more exotic and esoteric the cross, the wider the spread tends to be. Since the spread is a currency trader's main obstacle to profitability, we want to trade tight spreads that are easy to overcome. Good luck!
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 