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Going Global

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Correction: Original version had an incorrect byline

In February, U.S. equity traders went global, like it or not. Traders woke one February morning to learn that Chinese stock prices had collapsed and the yen carry trade was being unwound. U.S. futures were spiraling lower.

Few had even known the meaning of the phrase "yen carry trade" before that day, but many learned its meaning afterward. Across the globe, big money had been borrowing yen. Due to the cheap carrying costs, they were able to use borrowed funds to invest in other securities that yielded more than the carrying costs. Sometimes those other securities had been equities. Wish I'd thought of it. It was great. . . . except not on that day.

Even before that day, some traders had noticed something peculiar about a chart of the U.S. dollar's value against the yen (USDJPY). The movements on that chart seemed to lead or corroborate new developments on the equity charts.

At some point in the future, perhaps in the near future, inter-market relationships could change. If equities aren't escalating, why invest borrowed yen in equities? Consider that this week's dollar gain against the yen might be due at least in part to the political instability in Japan that makes it nearly impossible for the Bank of Japan to raise rates. Is big money going to take the risk that a new political regime will be welcomed with a firming yen? Will big money look at Goldman's experience, with one of the firm's global hedge funds burned in an unwinding yen carry trade, and take the same risk? That previous relationship might be unbuckled.

Either way, traders need to watch. As long as the USDJPY tends to lead or corroborate equity moves, traders can use the currency pair to determine where equities might go or whether a move might be sustained. When such judgments no longer appear to play out, traders will be forewarned that the inter-market relationship has unbuckled.

How, exactly, does one watch the currency pairs? Those who read my articles know that I prefer nested Keltner charts, but many find them confusing or their charting services don't afford them the opportunity to employ them.

That turns out not to be a big problem. Many forex traders believe the forex markets to be the cleanest or purest to trade on a technical basis. What does that mean? According to James Chen, writing "Support & Resistance Precision in Forex" for the August issue of STOCKS & COMMODITIES, that means that simple support and resistance studies may be all traders need when watching currencies. Rising and declining trendlines, horizontal support and resistance and formations such as channels can be important tools on forex charts.

Annotated Weekly Chart of the USDJPY:

Annotated Daily Chart of the USDJPY:

Annotated Daily Chart of the USDCAD:

So, if the forex markets trade nicely in relationship to trendlines, gaps, and other simple formations, how would one use that information as a prediction or corroboration of how equity markets might behave?

One example might be found on September 6 and 7, as seen on intraday charts.

Annotated 15-Minute Chart of the SPX:

Annotated 15-Minute Chart of the USDJPY:

The warnings or predictions offered by the USDJPY don't always work that cleanly. Especially lately, equities have sometimes appeared to lead currencies, rather than the other way around. That happened on September 11, for example, when the currency pair did not confirm early equity strength, but equities went on to post strong gains that finally seemed to pull the USDJPY higher, too. However, this hasn't happened often enough that traders can afford to ignore the actions of the currency pair. If they're breaking through resistance or support, traders should consider the possibility that equities might do so, too. If equities are breaking through and the currency pair is not, traders should prepare for the possibility that the equity move might not be sustained.

Which indices show the most correspondence to behavior in the USDJPY? My information is purely anecdotal, but watching has become particularly interesting. It used to seem that the Russell 2000 showed the most correspondence. Lately, however, the RUT hasn't seemed as responsive to gains in the USDJPY. This is just anecdotal evidence, but is that a sign that any yen being borrowed aren't as likely to be spent buying the less liquid small caps? The OEX, Dow and SPX have been more responsive to UDSJPY moves, particularly to any climb in the currency pair, so are any yen being borrowed being put to work buying more liquid large caps? If this is what's happening, it certainly would seem to be a sign of growing caution even among the big money crowd. Given what's happened to some big money players, I can't say I blame them for that caution.

I receive my currency feed through DTNIQ. I use either BUSDJPY or TUSDJPY for that feed. Other charting services may or may not include currency quotes and might use different symbols if they do include it.

Free currency charts and quotes can be found at http://finance.yahoo.com with the quotes available on the sidebar on the left of the home page. Clicking through calls up charts. Printing the charts allows one to draw trend-lines and determine support and resistance.

Drawing trend-lines by hand? That is going back to the beginnings of technical analysis, isn't it? While I wouldn't suggest trading the forex markets with hand-drawn trendlines as one's only technical study, that might be all the technical analysis you need if you're using the forex markets in the manner I do, as a sort of indicator index.
 

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