Analyzing technical themes

Technical themes are perhaps a little harder to grasp than fundamental themes, especially if you’re not familiar with technical analysis. But to make a long story short, sometimes currency prices move simply because currency prices are moving.

The economic or political fundamental themes may not have changed dramatically, but price levels have, and that is frequently enough to bring major market interest out of the woodwork.

In most cases, breaks of major technical or price levels will be in the direction suggested by the prevailing fundamental themes, but the timing is often suspect and can leave traders scratching their heads, asking what just happened. But sizable price movements have a way of taking on a life of their own, forcing market participants to take action based on price adjustments alone.

In addition, the prevalence of technical analysis as the basis for many trading decisions can add weight to existing fundamental-driven moves, generating yet another theme to propel the move - the technical theme. It may be a trending market movement that attracts trend-following traders who don't give a hoot about the underlying fundamentals. As long as the technical trend is in place, they keep pushing the market in the direction its going, prolonging the price adjustment perhaps far beyond what the fundamentals would dictate.

When a currency pair has broken through important technical levels, it’s also going to attract breakout traders - speculators who focus on jumping in on breaks of key price levels, looking to get in on the move for an easy trade. (But nothing is ever quite that easy, and breakout traders can suffer when the breaks are false and the ranges survive.) The additional interest entering the market in the direction of the move again propels the price farther and faster than it may ordinarily go.

Having a sense of where a currency pair stands from a technical perspective is always important, even if you’re not basing your trades on technical analysis. The technical-theme phenomenon also stems from several real-life considerations that all relate back to the relative level of currency prices:

• Option interest: The currency options market is massive and is one of  the reasons that the spot currency market is as large as it is. Option-related hedging is one of the biggest sources of spot market activity outside short-term spot speculation. When spot prices have been trading in well worn territory (a relatively narrow price range, for example), option interest tends to accumulate around the recent range. If the ranges are broken, sizeable option-related interest is frequently forced to come into the market and trade in the direction of the price breakout, either to unwind hedges or to cover new exposures created by the price break, and usually some combination of both. The amounts can be staggering, propelling the directional move in an extreme way.

• Systematic models: We look at so-called black box or algorithmic trading in “Hedge Funds”. Algorithmic trading has dramatically increased in size and number in recent years, which has added further weight to technical themes in day-to-day trading. In many cases, systematic-models trading decisions are generated based solely on price movements. They may be short a currency pair until a certain price level on the upside is traded, for example, which triggers a signal to exit the short and go long, no questions asked.

• Hedgers: Large-scale hedgers may be forced to come into the market if a rapid and unexpected price movement develops. Many firms identify an internal hedging rate for corporate and financial management purposes. As long as they’re able to sell above or buy below that rate, they’re looking good. If the market moves sharply on them, they may be forced to jump in on the direction of the move for fear of not ever seeing the internal hedging rate again.