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Aussie Ascending
The Australian Dollar is looking stout, forming an ascending triangle vs. the U. S. Dollar. AUD/USD faces strong resistance at .9500, a level it has been testing repeatedly since late February. There is no further resistance lying in wait above .9500. Meanwhile, AUD bulls have been buying the pair at higher and higher levels since mid-March (see figure 1).
Figure 1: AUD/USD forms and ascending triangle within and uptrend. Source: Saxo Bank
While the pair is having a tough time breaking out, this bullish formation is giving us clues as to the next destination for the currency pair. The triangle is an impressive feat in and of itself, because the U.S. Dollar has been doing well against just about every major currency for the past two weeks, including the mighty Euro. The previous uptrend confirms the bullish attitude of this currency pair. Aussie has also held its own despite the recent pullback in gold, which has fallen below $900 after briefly cresting above $1000. Gold, copper, nickel, and other metals are plentiful in Australia's mines, as the country is the world's third largest producer of the yellow metal. The commodities rally has benefitted the currency from Down Under, which seems unfazed by the recent pullback in gold.
Could 100.00 be in the cards for AUD/USD? It's still a long way off, but one could make a compelling case for Aussie at parity with the greenback. Look at the huge difference in interest rates between these two countries; the Reserve Bank of Australia (RBA) has a benchmark cash rate of 7.25%, while the U.S. Fed Funds rate is just 2.00%. The effect of this interest rate differential is to push money away from the low interest rate in the U.S. and toward the much higher rate offered by Australia. This advantage is compounded when you consider the opposite directions that these two central banks are heading. The RBA has already raised rates twice this year, for a total of 50 basis points, while Ben Bernanke's Fed has slashed an incredible 325 basis points since the Fed Funds rate peaked at 5.25%. Will Australia keep raising rates? In the RBA's quarterly Statement on Monetary Policy, which was released last week, they substantially raised the near term forecast for CPI inflation to peak this year at 4.5%. This high rate of inflation increases the likelihood that the RBA will be forced to continue raising interest rates, which should in turn propel the currency higher.
Why would higher interest rates have this effect? Think of the various countries as banks, with each bank setting the interest rate for an imaginary certificate of deposit. If two banks are equally safe, which one will get your money? Obviously the answer is the bank with the highest interest rate. Well, people who invest in bonds feel the same way; they want the best return that they can get without compromising the safety of the investment. There is a tremendous amount of capital out there seeking high quality, low risk investments such as government bonds. While the central bank rates generally reflect a target rate for overnight loans and do not always reflect the rates offered on longer term bonds, they are a useful general guide to the rates available in a country. When capital flows toward a country, the currency tends to strengthen, as we have seen in the case of Australia. Meanwhile, massive rate cutting by the Fed is helping to drive capital away from the U.S. It's no coincidence that the U.S. Dollar has weakened dramatically this year because of the availability of superior rates elsewhere, and the recent strength of the greenback can be attributed to speculation that Bernanke and the Fed might finally be ready to end their campaign of interest rate reductions. Regardless of what the Fed decides to do, Aussie rates should remain well above U.S. rates, generating a capital flow into Australia for the foreseeable future.
Sign of the Times
Real estate agents in the Hamptons, an exclusive beach community on Long Island, NY, report that many properties are being rented by Europeans this year. With the Euro much higher vs. the greenback than it was at this time last year, U.S. real estate is essentially "on sale" for both buyers and renters, and international travelers who might otherwise have spent their summers in the south of France or perhaps in the Greek Isles are opting for New York seaside towns better known for hosting hedge fund traders and money managers. Many of the overseas renters are picking up slack for a rental market that initially became sluggish after the Bear Stearns collapse and in the face of big potential layoffs in the U.S. financial sector.
Question of the Week
Q) Hi Ed, I have been trading about a year now, I only trade GBP/JPY as it offers me quite enough pips, I am a conservative trader who uses money management rules and I stick to my plan and I never risk more than a small percentage of my account. However I was wondering the other day if I should sometimes be risking more in certain situations. For example price always retraces at some point...so for example I have been looking back over charts of GBP/JPY and it appears that nearly all big (on my 3 hour chart) rallies last about 1000 pips, so when GBP/JPY does one of these big rallies it would surely mean profit taking would start to commence at a very near point and would make sense to take the other side of the trade and start adding shorts and possible bigger positions. Would this be a sensible method and time to risk more?
Ed Ponsi) Thank you for your email. First of all, congratulations on your successful trading; the Great Britain Pound – Japanese Yen (GBP/JPY) currency pair isn't for everyone, but it can create some massive moves and I'm glad to hear that you're catching them. My main concern is that you're considering making a big change in your trading, and changing the one thing that may be the most important aspect of trading, the amount of risk you allow yourself to take. I've known a lot of traders over the years, and regardless of their trading methodologies, the one thing the successful ones seem to have in common is good risk management techniques. The fact that you are successful now probably has something to do with your emphasis on risk control.
My point is this – if it ain't broke, don't fix it. Solid risk management may be the reason for your success, but so many of us get a taste of success and then we abandon the very thing that got us there in the first place. Try to look at it this way; if you are risking a fixed percentage of your account, and your account is growing in size due to your good work, then technically you are risking a larger sum of money. This is just my opinion, but I'd keep the risk percentage size the same. Whatever you decide, I wish you the best of 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 