Tactical trading consideration in GBP/USD and USD/CHF

The routine short-term volatility of cable and Swissy suggest several important tactical trading refinements. The overarching idea here is to adjust your trading strategies to weather the erratic price action and higher overall volatility in these pairs in comparison to the larger EUR/USD.

lt may help to think of sailing a boat on a lake. When the wind is calm, you need to ighten up the sails to catch all the wind you can. But when the wind starts gusting, you need to let out some slack on the sails or you’re liable to get blown over. The same is true when trading cable and Swissy.

Reducing position size relative to margin

This first consideration is especially important in cable, due to its high relative value to the USD. With GBP/USD trading around 1.90 to the dollar ($1 = $1.90) a one-lot position (£100,000) eats up $1,900 in required margin at 100:1 leverage. A similar-size position in EUR,/USD (at 1.30) takes up only $130,000 and costs $1,300 in margin. If you’re going to trade in cable, you’ll need more margin than if you stayed with EUR/USD, USD/JPY, or Swissy.

Cable and Swissy’s higher volatility also argue for overall smaller position sizes. A smaller position will allow you to better withstand their short-term volatility and give you greater staying power relative to margin. If you’re willing to risk $500 in capital on a particular trade, that equates to 50 pips in EUR/USD and GBP/USD. But the chances of an adverse move of 50 pips in GBP/USD are far greater (routine, actually) than a 50-pip move in E.UR/USD.

Allowing a greater margin of error on technical breaks

If you’re basing your trades on technical levels of support and resistance, you need to anticipate that those levels will be tested at the minimum. In sterling and Swissy, tests of technical levels frequently result in false breaks as stops are triggered. If your stop loss is too close to the technical level, it's ripe for the picking by the market. Factoring in a margin of error when placing stop-loss orders can help - allow you to withstand any short-term false break. Using a margin of error may also require you to reduce your position size to give you greater flexibility and margin staying-power.

Anticipating overshoots and false breaks for position entry

When you’re looking to enter a position by selling on rallies or buying on dips, you’re probably focused on selling at resistance and buying on support. You can take advantage of cable and Swissy’s tendency to overshoot or make false breaks of technical levels by placing your limit order behind the technical level (above resistance, below support). If cable and Swissy break through the level, you’d be able to enter at a better price than you would have if you’d adhered to the technical level alone.

Alternatively, you can enter a portion of your desired position at the technical level and enter the rest at better prices if the level is breached, improving the average rate of your position. Worst-case scenario, the market only fills you for half of your desired position and then reverses. Best-case scenario, you establish your full desired position-at a-better rate than you expected and the market reverses. If the market keeps going against you, at least your average position rate is better than it otherwise would have been.

Being quick on the trigger

Cable and Swissy tend to move very quickly and may not spend a lot of time around key price levels. This favors traders who are decisive and quick on the trigger in terms of entering and exiting positions. Having a disciplined trading plan in place before you enter the market helps. Above all, avoid being distracted from your plan by the sharper price movements.

Another way you can take advantage of the short-term volatility of cable and Swissy is by using resting orders to get in and out. You may not be in front of your trading screen, or your click-and-deal trade may not have made it through on a rapid price fluctuation. A standing limit order will accomplish the same trade - only automatically and instantly if the price deals. Trailing stops are especially useful when you have a position that‘s moving the right way.

Resisting the contrarian urge following large directional moves

After an extended directional price move, many traders may feel inclined to trade in the opposite direction, if only for a short-term correction. Maybe you missed -the big move and think it’s ripe for a pullback. Or maybe it looks like the move has gone too far, too fast. Resist that urge in cable and Swissy.

On days with large directional price moves of more than 100 pips, cable and Swissy often finish out the trading day at the extremes of the price move (meaning at the highs on an up-move and at the lows on a decline). So even if you sell the high of a move up, you’re unlikely to get any joy on the day.

Picking your spots wisely

Instead of simply jumping into sterling or Swissy, the way you may in EUR/USD, you’re going to need to do a fair amount of watching and studying to get a handle on where appropriate entry points may be. Short-term volatility in cable and Swissy make for treacherous short-term trading conditions. You’ll greatly improve your chances of catching a favorable move if you step back and look at the medium and longer-term pictures (four-hour and daily) instead of getting caught up in the short-term volatility.

Price action behavior of GBP/USD and USD CHF

I group these two currency pairs together because they share similar market liquidity and trading interest, which are the main drivers of price action. The more liquid a market is, the more smoothly prices will move; the thinner the market, the more erratically prices will move. In both pairs, liquidity and market interest tend to be the thinnest among the majors, especially outside of European trading hours. As a result, both pairs typically trade with wider 3 to 5 pip prices relative to narrower spreads in EUR/USD and USD/JPY.

The most important trading characteristics of sterling and Swissy are as follows:

• Price action tends to be jumpy, even in normal market. Cable and Swissy are like long-tailed cats in a room full of rocking chairs - extremely nervous. In a relatively calm market, you can see prices in these two pairs jump around by routine 2 to 3 pip increments (say, from 20/25 to 22/27 or 23/28, back to 21/26, and then 24/29)

When prices are moving in response to news or data, those price jumps can be even more pronounced, frequently changing by 3 to 5 pips between prices. Online traders are also likely to get more “rates changed” responses when trying to deal on the current market price. That response means the price changed by the time your trade request was received and the attempted trade was not completed. The subsequent price may be 2 to 3 pips higher or lower than where you first tried to deal.

• Price action tends to see one-way traffic in highly directional markets. When news or data move the market, the price changes in Swissy and cable are apt to be the most abrupt. If a data report sends EUR/USD higher by a quick 20 to 30 pips, cable and Swissy are likely to see prices move by 30 to 40 pips or more. On top of that, cable and Swiss will remain highly directional and tend to see minimal pullbacks or backing and filling.

• Look at cable and Swissy as leading indicators for EUR/USD. One of the ways that experienced traders judge the level of buying or selling interest, how bid or offered a market is, during a directional move is by looking at how cable and Swissy are trading. For example, if bids in USD/CHF keep appearing in a relatively orderly fashion, say every 1 to 2 pips on a downswing, it’s a sign that the move is not especially extreme. On the other hand, ft the prices are dropping by larger increments and displaying very few bounces, it’s a strong indication that a larger move is unfolding.

• False breaks of technical levels occur frequently. Cable and Swissy also have a nasty habit of breaking beyond technical support and resistance levels, only to reverse-course and then trade in the opposite direction. And we’re not talking about just a few points beyond the level here, but more like 25 to 30 pips in many cases. The frequency of false breaks is a result of the relatively lower level of liquidity and market interest in these pairs. Instead of having a selling order at technical resistance, which you may reasonably expect in EUR/USD or USD/JPY, there may only be a stop-loss buying order beyond the resistance in cable and Swissy.

• Spike reversals are very common. The tendency of cable and Swissy to overshoot in extreme directional moves and to generate false breaks of technical levels means that spike reversals appear frequently on short term charts. Though the size of the spikes will vary depending on the market circumstances and current events, spike reversals of more than 30 to 40 points on an hourly closing basis should alert you to a potentially larger reversal taking place. The bigger the spike reversal (and it’s not uncommon to see 50 to 70 pip spikes in cable and Swissy), the more significance it holds for the future direction. 

Safe haven or panic button: USD/CHF

The Swiss franc has, or we should say had, a reputation for being a safe-haven currency. Apart from Switzerland's historical neutrality and legendary bank secrecy laws, this reputation is largely a relic of the Cold War. At the time, fears of a European ground war between the United States and the Soviet Union meant most European financial centers could be out of business in short order. In terms of a major European currency alternative to U.S. dollars or German deutsche marks, the CHF became the safe-haven currency during times of geopolitical tensions.

There are still plenty of people in the market who continue to refer to the CHF as a safe-haven currency and, indeed, knee-jerk buying of CHF will frequently occur in response to geopolitical crises or terrorism. But those market reactions are increasingly very short-lived, usually only a few minutes or hours now, before pre-existing trends reassert themselves.

Trading fundamentals of USD/CHF

Instead of portraying it as a safe-haven currency pair, I prefer to view USD/CHF as the panic button of forex markets. When unexpected geopolitical news hits the proverbial fan, USD/CHF usually reacts the fastest and the farthest.

In terms of overall market volume, USD/CHF only accounts for 4 percent of global daily trading volume according to the 2004 BIS survey. With such a small share of market turnover, you’d be right in wondering why it‘s considered a major pair in the first place. In terms of liquidity, Swissy is not a major.

Trading USD/CHF by the numbers

USD/CHF is quoted in terms of the number of CHF per USD. At a USD/CHF rate of 1.2545, it costs CHF 1.2545 to buy $1. USD/CHF trades in the overall direction of the U.S. dollar and inversely to the CHF. If the USD/CHF rate moves higher, the USD is strengthening and the CHF is weakening. The USD is the primary currency in the pairing, and the CHF is the secondary currency. That means

·     USD/CHF is traded in amounts denominated in USD. In online currency trading platforms, standard lot sizes are $100,000, and mini lot sizes are  $10,000.

·        The pip value, or minimum price fluctuation, is denominated in CHF.

·        Profit and loss accrues in CHF. For one standard lot position size, each pip is worth CHF 10; for one mini lot position size, each pip is worth CHF 1. To convert those amounts to USD, divide the CHF amount by the USD/CHF rate. Using 1.2500 as the rate, CHF 10 = $8 and CHF 1 = $0.80. The pip value will change over time as the level of the USD/CHF exchange rate fluctuates, with a lower USD/CHF rate giving a higher pip value in USD terms, and vice versa.

·         Margin calculations are typically calculated in USD. So it’s a straight forward calculation using the leverage rate to see how much margin is required to hold a position in USD/JPY. At 100:1 leverage, $1,000 of available margin is needed to open a standard-size position of 100,000 USD/CHF

Keeping the focus on Europe

When looking at economic fundamentals, its worth remembering that Switzerland conducts the vast share (about 80 percent) of its foreign trade with the Eurozone and remaining EU countries. So when it comes to the value of the CHF, the Swiss are most concerned with its level against the EUR as opposed to the USD.

The Swiss National Bank (SNB), the Swiss central bank, tends to get involved  in the forex market only when the Swiss franc is either too strong or too weak against the euro. If the CHF is too weak, it can import inflation (higher CHF prices for the same goods), upsetting the SNB’s carefully laid plans to tame inflation. If the CHF is too strong, it can hurt Swiss exports (more euros needed to buy the same Swiss goods).

The SNB typically prefers to use verbal intervention to influence the value of the CHF, and SNB comments frequently stir up USD/CHF and EUR/CHF trading. Since the introduction of the euro in 1999, EUR/CHF has been confined mostly to a relatively narrow range of 1.5000 to 1.6200, but as of this writing it’s pushing toward 1.65, drawing increased criticism from the SNB.

Important Swiss economic reports

Swiss data tends to get lost in the mix of data reports out of the United States and the Eurozone, with many in the market looking at Switzerland as a de facto Eurozone member. In that sense, market reactions to Swiss data and events primarily show up in EUR/CHF cross rates. The important Swiss data to keep an eye on are

• SNB rate decisions and speeches by directorate members
• KOF Index of Globalization Swiss leading indicator
• Retail sales
• Trade balance
• PPI and CPI
• Unemployment rate

The Other Majors: Sterling and Swiss

The other two major currency pairs are GBP/USD (affectionately known as sterling or cable) and USD/CHF (called Swissy by market traders). These two are counted as major currency pairs but their trading volume and liquidity are significantly less than EUR/USD or USD/JPY. As a result, their trading characteristics are very similar to each other. We will look at their individual trading fundamentals separately and then discuss their trading behavior and tactical trading considerations together.

The British pound: GBP/USD

Trading in cable presents its own set of challenges, because the pair is prone to sharp price movements and seemingly chaotic price action. But it’s exactly this type of price behavior that keeps the speculators coming back - when you’re right, you’ll know very quickly, and the short-term results can be significant.

Trading fundamental of GBP/USD

The UK economy is the second largest national economy in Europe, after Germany, and the pound is heavily influenced by cross-border trade and mergers and acquisitions (M&A) activity between the United Kingdom and continental Europe. Upwards of two-thirds of UK foreign trade is conducted with EU member states, making the EUR/GBP cross one of the most important trade-driven cross rates.

The 2004 BIS survey of foreign exchange turnover showed that GBP/USD accounted for 14 percent of global daily trading volume, making cable the third most active pairing in the majors. But you may not believe that when you start trading cable, where liquidity seems always to be at a premium. Relatively lower liquidity is most evident in the larger bid-offer spread, which is usually 3 to 5 pips compared to 2 to 4 pips in EUR/USD and USD/JPY.

Trading sterling by the numbers

GBP/USD is quoted in terms of the number of dollars it takes to buy a pound, so a rate of 1.8515 means it costs $1.8515 to buy £1. The GBP is the primary currency in the pair and the USD is the secondary currency. That means

• GBP/USD is traded in amounts denominated in GBP. In online currency trading platforms, standard lot sizes are £100,000, and mini lot sizes are £10,000.
•  The pip value, or minimum price fluctuation, is denominated in USD.
• Profit and loss accrue in USD. For one standard lot position size, each pip is worth $10; for one mini lot position, size, each pip is worth $1.
• Margin calculations are typically calculated in USD in online trading platforms. Because of its high relative value to the USD, trading in GBP pairs requires the greatest amount of margin on a per-lot basis. At a GBP/USD rate of 1.9000, to trade a one-lot position worth £100,000, it’ll take $1,900 in available margin (based on 100:1 leverage). That calculation will change over time, of course, based on the level of the GBP/USD exchange rate. A higher GBP/USD rate will require more USD in available margin collateral, and a lower GBP/USD rate will need less USD in margin.

Trading alongside EUR/USD, but with a lot more zip!

Cable is similar to the EUR/USD in that it trades inversely to the overall USD. But While EUR/USD frequently gets bogged down in tremendous two-way liquidity, cable exhibits much more abrupt volatility and more extreme overall price movements. If U.S. economic news disappoints, for instance, both sterling and EUR/USD will move higher. But if EUR/USD sees a 60-point rally on the day, cable may see a 100+ point rally.

This goes back to liquidity and a generally lower level of market interest in cable. In terms of daily global trading sessions, cable volume is at its peak during the UK/European trading day, but that level of liquidity shrinks considerably in the New York afternoon and Asian trading sessions. During those off-peak times, cable can see significant short-term price moves simply on the basis of position-adjustments (for example, shorts getting squeezed out).

Another important difference between cable and EUR/USD comes in their different reactions to domestic economic/news developments. Cable tends to display more explosive reactions to unexpected UK news/data than EUR/USD does to similar Eurozone news/data. For example, if better than expected Eurozone data comes out, EUR/USD may only politely acknowledge the data and move marginally higher. But if surprisingly strong UK data is reported, GBP/USD can take off on a moonshot.

Important UK data reports

Cable tends to react sharply to UK economic reports, especially when the data is in the opposite direction of expectations, or when the data is contrary to current monetary policy speculation. For example, if the market is expecting that the next rate move by the Bank of England (BOE) will be higher, and a monthly inflation report is released indicating a drop in price pressures, then GBP/USD is likely to drop quickly as interest rate bets are unwound.

Key UK data reports to watch for are

·      BOE Monetary Policy Committed (MPC) rate decisions, as well as speeches by MPC members and the BOE governor

·         BOE MPC minutes (released two weeks after each MPC meeting)

·         Inflation gauges, such as CPI, PPI, and the British Retailers Consortium  (BRC) shop price index

·         Retail sales and the BRC retail sales monitor

·         Royal Institution of Chartered Surveyors (RICS) house price balance

·         Industrial and manufacturing production

·         Trade balance

·         GFK (a private market research firm) UK consumer confidence survey

Tactical trading considerations in USD/JPY

Before this I mention that USD/JPY’s tendency to either be active directionally or consolidating - the on/ off switch. As such, we like to approach USD/JPY on a more strategic, hit-and-run basis - getting in when we think a directional move is happening and standing aside when we don't. We look for breaks of trend lines, spike reversals and candlestick patterns, as our primary clues for - spotting a pending directional move.

On the tactical level, USD/JPY is generally a cleaner trading market than most of the other majors, so I like to approach it with generally tighter trading rules. The idea is that if I’m right, we’ll be along for the ride. But if I’m wrong, we jump off the bus at the next stop.

Actively trading trend-line and price-level breakouts

One of my trigger points for jumping into USD/JPY is breaks of trend lines and key price levels, such as daily or weekly highs/lows. Earlier I said that it usually takes a significant amount of market interest to break key technical levels. We look at the actual breaks as concrete evidence of sizeable interest, rather than normal back-and-forth price action.

Jumping on spike reversals

After USD/JPY has seen a relatively quick (usually within two to three hours) move of more than 70 to 80 pips in one direction, we’re on the lookout for any sharp reversals in price. Spike reversals of 30 to 40 pips that occur in very short timeframes (5 to 20 minutes) are relatively common in USD/JPY. But you pretty much have to be in front of your trading screen to take advantage of these, because they’re a short-term phenomenon by their very nature.

Monitoring EUR/JPY and other JPY crosses

USD/JPY is heavily influenced by cross flows and can frequently take a back seat to them on any given day. In evaluating USD/JPY, we always keep an eye on the JPY crosses and their technical levels as well. A break of important support in GBP/JPY, for instance, could unleash a flood of short-term USD/JPY selling, because GBP/JPY is mostly traded through the dollar pairs.

EUR/JPY is the most actively traded JPY cross and its movements routinely drive USD/JPY on an intraday basis. Be alert for when significant technical levels in the two pairs coincide, such as when both USD/JPY and EUR/JPY are testing a series of recent daily highs or lows. A break by either can easily spill into the other and provoke follow-through buying/selling in both. 

Price action behaviour of USD/JPY

In my previous post, we note that USD/JPY seems to haze an on/off switch when compared to the other major currency pairs. Add to that the fact that USD/JPY liquidity can be similarly fickle. Sometimes, hundreds of millions of USD/JPY can be bought or sold without moving the market noticeably; other times, liquidity can be extremely scarce.

This phenomenon is particularly acute in USD/JPY owing to the large presence of Japanese asset managers. As mention in my post before this,  the Japanese investment community tends to move en masse into and out of positions. Of course, they're not the only ones involved in USD/JPY, but they do tend to play the fox while the rest of the market is busy playing the hounds.

Prone to short-term trends, followed by sideways consolidations

The result of this concentration of Japanese corporate interest is a strong tendency for USD/JPY to display short-term trends (several hours to several days) in price movements, as investors pile in on the prevailing directional move. This tendency is amplified by the use of standing market orders from Japanese asset managers.

For example, if a Japanese pension fund manager is looking to establish a long position in USD/JPY, he’s likely to leave orders at several fixed levels below the current market to try to buy dollars on dips. If the current market is at 116.00, he may buy a piece of the total position there, but then leave orders to buy the remaining amounts at staggered levels below, such as 115.75, 115.50, 115.25, and 115.00. If other investors are of the same view, then they‘ll be bidding below the market as well.

If the market begins to move higher, the asset managers may become nervous that they won’t be able to buy on weakness and raise their orders to higher levels, or buy at the market. Either way, buying interest is moving up with the price action, creating a potentially accelerating price movement. Any countertrend move is met by solid buying interest and quickly reversed.

Such price shifts tend to reach their conclusion when everyone is onboard - most of the buyers who wanted to buy are now long. At this point, no more fresh buying is coming into the market, and the directional move begins to stall and move sideways. The early buyers may be capping the market with profit-taking orders to sell above, while laggard buyers are still buying on dips. This leads to the development of a consolidation range, which can be as wide as ¥l or ¥2, or as narrow as 40 to 50 pips.

Short-term traders can usually find trading opportunities in such consolidation ranges, but medium and longer-term traders may want to step back and wait for a fresh directional movement.

Technical levels are critical in USD/JPY

So if you‘re a regular trader or investor and you don’t work at a Japanese bank, how can you know where the orders are? Simple: Focus on the technical levels.

Perhaps no other currency pair is as beholden to technical support and resistance as USD/JPY. In large part, this has to do with the prevalence of substantial orders, where the order level is based on technical analysis. USD/JPY displays a number of other important trading characteristics when it comes to technical trading levels:

• USD/JPY tends to respect technical levels with far fewer false breaks. This situation is typically due to the presence of substantial order interest at the technical level. If trend-line analysis or daily price lows indicate major support at 118.20, for example, sizeable buying orders are likely to be located there. The bank traders watching the order may buy in front of it, preventing the level from ever being touched, or tested. If the selling interest is not sufficient to fill the buying order, the level will hold. On the other hand, if the technical level is breached, it’s a clear indication the selling interest is far greater and is likely to continue.
• USD/JPY’s price action are usually highly directional (one-way traffic) on breaks of technical support and resistance. When technical support or resistance is overcome, price movements tend to be sharp and one-sided, with minimal pullbacks or backing and filling (prices coming back to test the breakout level). This situation is the result of strong market interest overcoming any standing orders, as well as likely stop-loss orders beyond the technical level.
• Spike reversals (sharp – 20 to 50 pip price movements in the opposite direction of the prior move) from technical levels are relatively common. Spike reversals are evidence of a significant amount of market interest in the opposite direction and frequently define significant highs and lows. They’re also evidence that the directional move that was reversed was probably false, which suggests greater potential in the direction of the reversal.
• Orders frequently define intraday highs and lows and reversal points. Japanese institutional orders also tend to be left at round-number prices, such as 118.00, 118.25, or 118.50. When you look at charts involving JPY, always note tops/bottoms are close to round number price levels because there could be significant orders there.

East Meets West: USD/JPY

USD/JPY is one of the more challenging currency pairs among the majors and trading in it requires a higher degree of discipline and patience. Where other currency pairs typically display routine market fluctuations and relatively steady, active trading interest, USD,/JPY seems to have an on/oft switch. It can spend hours and even days in relatively narrow ranges and then march off on a mission to a new price level.

USD/JPY can offer some of the clearest trade setups among the major pairs. When you’re right in USD/JPY, the returns can be astonishingly quick. When you’re wrong in USD/JPY, you’ll also know it pretty quickly. The key to developing a successful trading game plan in USD/JPY is to understand what drives the pair and the how price action behaves.

Trading fundamentals of USD/JPY

The Japanese yen is the third major international currency after the U.S. dollar and the European single currency, the euro. USD/JPY accounts for 17 percent of daily global trading volume, according to the 2004 BIS survey of exchange markets. Japan stands as the second largest national economy after the United States in terms of GDP and the JPY represents the third major currency group after the USD and the EUR groupings.

Trading USD/JPY by the numbers

Standard market convention is to quote USD/JPY in terms of the number of JPY per USD. For example, a USD/JPY rate of 115.35 means that it takes ¥115.35 to buy $1.

USD/JPY trades in the same direction as the overall value of the USD, and inversely to the value of the JPY. If the USD is strengthening and the JPY is weakening, the USD,/JPY rate will move higher. If the USD is weakening and the JPY is strengthening, the USD/JPY rate will move lower.

USD/JPY has the U.S. dollar as the base currency and the JPY as the secondary or counter currency. This means,

• USD/JPY is traded in amounts denominated in USD. In online currency trading platforms, standard lot sizes are $100,000, and mini lot sizes are $10,000.
• The pip value, or minimum price fluctuation, is denominated in JPY.
• Profit and loss accrue in JPY. For one standard lot position size, each pip is worth ¥1000; for one mini lot position size, each pip is worth ¥100. To convert those amounts to USD, divide the JPY amount by the USD/JPY rate. Using 115.00 as the rate, ¥l,000 = $8.70 and ¥l00 = $0.87
• Margin calculations are typically calculated in USD. So it’s a straight forward calculation using the leverage rate to see how much margin is required to hold a position in USD/JPY. At 100:1 leverage, $1,000 of available margin is needed to open a standard-size position of 100,000 USD/JPY.

It's politically sensitive to trade

USD/JPY is the most politically sensitive currency pair among the majors. Japan remains a heavily export-oriented economy, accounting for more than 40 percent of overall economic activity. This means the JPY is a critical policy lever for Japanese officials to stimulate and manage the Japanese economy and they aren’t afraid to get involved in the market to keep the JPY from strengthening beyond desired levels.

A weak currency makes a nation‘s exports cheaper to foreigners and, all other things being equal, creates a competitive advantage to gain market share. The flip side of a weak currency is that it makes imports from abroad more expensive, putting foreign exporters at a disadvantage in the domestic market.

In the past, this has led to accusations of currency manipulation by trade partners and efforts to force the JPY to strengthen. But with China's incredible growth in this decade, lil’ ol’ Japan and the yen seem to have dropped from the radar screen as the primary target of free-market advocates. But this is more a function of China's vast current and future potential rather than any change to how the Japanese effectively manage the JPY.

The Ministry of Finance is routinely involved in the Forex market

Currency intervention is usually a last resort for most major national governments. Instead, the Japanese Ministry of Finance (MOF) engages in routine verbal intervention in not-so-subtle attempts to influence the level of the JPY.The chief spokesman on currencies is, of course, the Minister of Finance, but the Vice Finance Minister for International Affairs is the more frequent commentator on forex market developments.

The Japanese financial press devotes a tremendous amount of attention to the value of the JPY, similar to how the U.S. financial media cover the Dow or S&P 500. Press briefings by MOF officials are routine. During times of forex  market volatility, expect near-daily official comments. These statements move USD/JPY on a regular basis.

Beyond such jawboning, known as verbal intervention, the MOF has been known to utilize covert intervention through the use of sizeable market orders by the pension fund of the Japanese Postal Savings Bank, known as Kampo. This is sometimes referred to as semi official intervention in various market commentaries.

JPY as a proxy for other Asian currencies

The JPY is sometimes considered as a proxy for other Asian currencies that are not freely convertible or have poor liquidity or other trading restrictions, such as the Korean won, Chinese yuan, or the Taiwan dollar. Speculation that the Chinese government would revalue (strengthen) the Chinese yuan relative to the USD in early 2005 led to speculation that the JPY would also strengthen.

Japanese asset managers tend to move together

If Americans are the ultimate consumers, then the Japanese are the consummate savers. The Japanese savings rate (the percentage of disposable income that’s not spent) is around 15 percent. (Compare that with the U.S. savings rate at around -1 percent!) As a result, Japanese financial institutions control trillions of dollars in assets, many of which find their way to investments outside of Japan. The bulk of assets are invested in fixed income securities and this means Japanese asset managers are on a continual hunt for the best yielding returns.

This theme has taken on added prominence in recent years due to extremely low domestic yields in Japan. The continual off-shoring of JPY-denominated assets leads to continual selling of JPY to buy the currencies of the ultimate investment destination. This makes domestic interest-rate yields in Japan a key long-term determinant of the JPY’s value.

Japanese financial institutions also tend to pursue a highly collegial approach to investment strategies. The result for forex markets is that Japanese asset managers tend to pursue similar investment strategies at the same time, resulting in tremendous asset flows hitting the market over a relatively short period of time. This situation has important implications for USD/JPY price action.

Important Japanese data reports

Keep in mind that politics and government officials’ (MOF) comments are quite frequent and can shift market sentiment and direction as much as, or more than, the fundamental data. The key data reports to focus on coming out of Japan are:

• Bank of Japan (BOJ) policy decisions, monthly economic assessments, and Monetary Policy Committee (MPC) member speeches
• Tankan Report (a quarterly sentiment survey of Japanese firms by the BOJ - the key is often planned capital expenditures)
• Industrial production
• Machine orders
• Trade balance and current account
• Retail trade
• Bank lending
• Domestic Corporate Goods Price index (CGPI)
• National CPI and Tokyo-area CPI
• All-Industry Activity Index and Tertiary Industry (service sector) Activity Index

Tactical trading considerations in EUR/USD

We’ve looked at the major trading attributes of EUR/USD and now its time to look at how those elements translate into real-life trading tactics. After all, that’s where the real money is made and lost.

Deciding whether it’s a U.S. dollar move or a euro move

As discussed in my previous post,  I mention that EUR/USD routinely acts as the primary vehicle for forex markets to express their view on the USD. At the same time, I also indicated that EUR/USD will also react to euro-centric news and data. So for traders approaching EUR/USD on any given day, it helps to understand whether the driving force at work is dollar-based or euro-based. Are they bearish on the USD, or are they bullish on the EUR? Or is it some combination of the two?

Having a sense of which currency is driving EUR/USD at any given moment is important so you can better adapt to incoming data and news. If it’s a EUR-based move higher, for instance, and surprisingly positive USD news or data is released later in the day, guess what? We’ve got countertrend information hitting the market, which could spark a reversal lower in EUR/USD (in favour of the dollar). By the same token, if that U.S. data comes out weaker than expected, it’s likely to spur further EUR/USD gains, because EUR-buying interest is now combined with USD-selling interest.

Being patient in EUR/USD

Also in my previous post,  we explore why EUR/USD can spend hours trading in relatively narrow ranges or testing technical levels. The key in such markets is to remain patient based on your directional view and your technical analysis. You should be able to identify short-term support that keeps an upside test alive or resistance that keeps a down-move going. If those levels fail, the move is ‘stalling at the minimum and may even be reversing.

Taking advantage of backing and filling

Because EUR/USD tends to retrace more of its short-term movements, you can usually enter a position in your desired direction by leaving an order to buy or sell at slightly better rates than current market prices may allow. If the post-08:30 ET U.S. data price action sees EUR/USD move lower, and you think getting short is the way to go, you can leave an offer slightly (roughly 5 to 10 pips) above the current market level and use it to get short, instead of reaching out and hitting the bid on a downtick.

If your order is executed, you’ve got your desired position at a better rate than if you went to market, and you’re probably in a better position rhythm-wise with the market (having sold on an up-tick). Alternatively, you can take advantage of routine backing and filling by dealing at the market by selling on up-ticks and buying on down-ticks.

Allowing for a margin of error on technical levels

When it comes to determining whether EUR/USP has broken a technical level, we like to use a 10- to l5-pip margin of error. Shorter-term traders may want to use a smaller margin of error.) Some very short-term traders and technical purist like to pinpoint an exact price level as support or resistance. If the market trades above or below their level, they’ll call it a break and that’s that. But the spot forex market rarely trades with such respect for technical levels to make such a clear and pinpointed distinction. And given the amount of interest in EUR/USD, it’s especially prone to hazy technical lines in the sand.

The key point to take away from this is that all sorts of interest emerge around technical levels, and it’s still going through the market even though the pinpointed level might have been breached. And this is where our margin of error comes in. Again, it’s not a hard and fast rule, but generally speaking, EUR/USD will have chewed through most of the market interest around a technical level within about 10 to 15 points beyond the level. 

Trading Behavior of EUR/USD)

The deep liquidity and tight trading spreads in EUR/USD make the pair ideal for both shorter-term and longer-term traders. The price action behavior in EUR/USD regularly exhibits a number of traits that traders should be aware of.

Trading tick by tick

In normal market conditions, EUR/USD tends to trade tick by tick, as opposed to other currency pairs, which routinely display sharper short-term price movements of several pips. In trading terms, if EUR/USD is trading at 1.2910/13, there are going to be traders looking to sell at 13, 14, and 15 and higher, while buyers are waiting to buy at 9, 8, 7 and lower.

In contrast, other less-liquid currency pairs, like GBP/USD and USD/CHF, typically fluctuate in a far jumpier fashion, which is reflected by the wider price spread in those pairs.

Fewer price jumps and smaller price gaps

The depth of liquidity in EUR/USD also reduces the number of price jumps or price gaps in short-term trading. A price jump refers to a quick movement in prices over a relatively small distance (roughly 10 to 20 pips) in the course of normal trading. A price gap means prices have instantaneously adjusted over a larger price distance, typically in response to a news event or data release.

Don’t get me wrong, price jumps/gaps do occur in EUR/USD, as anyone who has traded around data reports or other news events can attest. But price jumps/gaps in EUR/USD tend to be generated primarily by news/data releases and breaks of significant technical levels, events which can usually be identified in advance.

This is in contrast to other major currency pairs where short-term price gaps can develop from a one-off market flow, such as a portfolio manager selling a large amount of GBP/USD or a USD/CHF stop-loss order being triggered. When price gaps do occur in EUR/USD, they tend to be smaller relative to gaps in other pairs. 

Backing and filling

When prices move rapidly in one direction, they tend to reach a short-term stopping point when opposite interest enters the market. For instance, let’s say EUR/USD just traded higher from 1.2910/13 to 1.2922/25 in relatively orderly fashion, tick by tick over two minutes, meaning no price gaps. When the price move higher pauses, short-term traders who were long for the quick 12-pip move higher will look to exit and sell.

As selling interest begins to enter the market and prices stop rising, other not-so-fast longs will also start hitting bids (selling), pushing prices lower. From the other side, traders who missed the quick run up, or who were not as long as they wanted to be, will enter their buying interest in the market. Other buyers, sensing selling interest, may wait and place their buying interest at slightly lower levels. This back-and-forth consolidation after a short-term price movement is referred to as backing and filling. The price backs up and fills the short-term movement, though it can happen in both up and down price movements.

When it comes to EUR/USD price action, backing and filling is quite common and tends to be more substantial than in most currency pairs, meaning a greater amount of the directional move is retracecl. Look at figure below to get a visual idea of what backing and filling looks like. When EUR/USD is not backing and filling the way you would expect, it means the directional move is stronger and with greater interest behind it.

Figure: A one minute EUR/USD chart showing periods of backing and filling price action after short-term directional moves. Backing and filling occurs in price declines, too.

Prolonged tests of technical levels

When it comes to trading around technical support and resistance levels, EUR/USD can try the patience of even the most disciplined traders. We say this because EUR/USD can spend tens of minutes (an eternity in forex markets) or even several hours undergoing tests of technical levels.

This goes back to the tremendous amount of interest and liquidity that defines the EUR/USD market. All those viewpoints come together in the form of market interest (bids and offers) when technical levels come into play. The result is a tremendous amount of market interest that has to be absorbed at technical levels, which can take time.

Looking at GBP/USD) and USD/CHF as leading indicators

Given the tremendous two-way interest in EUR/USD, it can be very difficult to gauge whether a test of a technical level is going to lead to breakout or a rejection. To get an idea of whether a test of a technical level in EUR/USD is going to lead to a break, professional EUR/USD traders always keep an eye on GBP/USD and USD/CHF, as they tend to be leading indicators for the bigger EUR/USD and dollar moves in general.

If GBP/USD and USD/CHF are aggressively testing (trading at or through the technical level with very little pullback) similar technical levels to EUR/USD (for example, daily highs or equivalent trend-line resistance), then EUR/USD is likely to test that same level. If GBP/USD and USD/CHF break through their technical levels, the chances of EUR/USD following suit increases. By the same token, if GBP/USD and USD/CHF are not aggressively testing the key technical level, EUR/USD is likely to see its similar technical level hold.

GBP/USD and USD/CHF lead times can be anywhere from a few seconds or minutes to several hours and even days. Just make sure you’re looking at the equivalent technical levels in each pair.

The vast majority of trading volume takes place in the major currency pairs: EUR/USD, USD/JPY, GBP/USD, and USD/CHF. These currency pairs account for about two-thirds of daily trading volume in the market and are the most watched barometers of the overall forex market. When you hear about the dollar rising or falling, it’s usually referring to the dollar against these other currencies.

Even though these four pairs are routinely grouped together as the major currency pairs, each currency pair represents an individual economic and political relationship. We will look at the fundamental drivers of each currency pair to see what moves them. We will also look at the market's quoting conventions and what they mean for margin-based trading.

Although it’s important to understand why a currency rate moves, I think it’s also essential to have an understanding of how different pairs’ rates move. Most currency trading is very short-term in nature, typically from a few minutes to a few days. This makes understanding a currency pair’s price action (how a currency pair‘s price moves in the very short term) a key component of any trading strategy. 

The Big Dollar: EUR/USD

EUR/USD is by far the most actively traded currency pair in the global forex market. Everyone and his brother, sister, and cousin trades EUR/USD. This will come as no surprise to anyone who has traded in the forex market, because if you have, more likely than not you traded EUR/USD at some point.

 The same goes for the big banks. Every major trading desk has at least one and probably several, EUR/USD traders. This is in contrast to less liquid currency pairs such as GBP/USD or AUD/USD, for which trading desks may not have a dedicated trader. All those EUR/USD traders add up to vast amounts of market interest, which increases overall trading liquidity.

Trading fundamentals of EUR/USD

EUR/USD is the currency pair that pits the U.S dollar against the single currency of the Eurozone, the euro. The Eurozone refers to a grouping of countries in the European Union (EU) that in 1999 retired their own national currencies and adopted a unified single currency. In one fell swoop, at midnight on January 1, 1999, the Deutsche mark, Italian lira, French franc, and nine other European currencies disappeared and the euro came into being.

The move to a single currency was the culmination of financial unification efforts by the founding members of the European Union. In adopting the single currency, the nations agreed to abide by fiscal policy constraints that limited the ratio of national budget deficits to gross domestic product (GDP), among other requirements. The nations also delegated monetary policy (setting interest rates) to the newly founded European Central Bank (ECB).

As of this printing, the countries that use the euro are: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Slovenia, and Spain. All together, the Eurozone constitutes a regional economic bloc roughly equal to the United States in both population and total GDP.

Trading EUR/USD by the numbers

Standard market convention is to quote EUR/USD in terms of the number of USD per EUR. For example, a EUR/USD rate of 1.3000 means that it takes $1.30

to buy €l.

EUR/USD trades inversely to the overall value of the USD, which means when EUR/USD goes up; the euro is getting stronger and the dollar weaker. When EUR/USD goes down, the euro is getting weaker and the dollar stronger. If you believed the U.S. dollar was going to move higher, you’d be looking to sell EUR/USD. If you thought the dollar was going to weaken, you'd be looking to buy EUR/USD.

EUR/USD has the euro as the base currency and the U.S. dollar as the secondary or counter currency. That means

• EUR/USD is traded in amounts denominated in euros. In online currency trading platforms, standard lot sizes are €100,000, and mini lot sizes are € 10,000.
• The pip value, or minimum price fluctuation, is denominated in USD.
• Profit and loss accrue in USD. For one standard lot position size, each pip is worth $10; for one mini lot position size, each pip is worth $1.
• Margin calculations in online trading platforms are typically based in USD. At a EUR/USD rate of 1.3000, to trade a one-lot position worth €l00, 000, it’ll take $1,300 in available margin (based on 100:1 leverage). That calculation will change over time, of course, based on the level of the EUR/USD exchange rate. A higher EUR/USD rate will require more USD in available margin collateral, and a lower EUR/USD rate will need less USD in margin.

Swimming in deep liquidity

Liquidity in EUR/USD is unmatched by other major currency pairs. This is most evident in the narrower trading spreads regularly available in EUR/USD.

Normal market spreads are typically around 2 to 3 pips versus 3 to 5 pips in other major currency pairs.

In terms of concrete numbers, EUR/USD accounted for 28 percent of global daily trading volume, according to the 2004 Bank for International Settlements (BIS) survey of the foreign exchange markets. That’s more than one and a half times the volume of the next most liquid currency pair (USD/JPY).

Liquidity in EUR/USD is based on a variety of fundamental sources, such as

• Global trade and asset allocation: The Eurozone constitutes the second largest economic bloc after the United States. Not only does this create tremendous commercial trade flows, but it also makes Eurozone financiall markets, and the euro, the destination for massive amounts of international investment flows. In April 2007, overall European stock-market valuations surpassed the value of U.S. equity markets for the first time ever.
• Central bank credibility: The ECB has established itself in the eyes of global investors as an effective institution in fighting inflation and maintaining currency stability.
• Enhanced status as a reserve currency: Central banks around the world hold foreign currency reserves to support their own currencies and improve market stability. The euro is increasing in importance as an alternative global reserve currency to the U.S. dollar.

The euro also serves as the primary foil to the U.S. dollar when it comes to speculating on the overall direction of the U.S dollar in response to U.S news or economic data. If weak U.S. economic data is reported, traders are typically going to sell the dollar, which begs the question, “Against what?" The euro is the first choice for many, simply because it's there. It also helps that it’s the most liquid alternative, allowing for easy entry and exit. ,

This is not to say that EUR/USD only reacts to U.S. economic data or news. On the contrary, Eurozone news and data can move EUR/USD as much as U.S data moves the pair. But the overall tendency still favors U.S data and news as the driving force of short-term price movements.

This situation is partly a function of geography and daily trading rhythms, because European data is released about four to eight hours before U.S economic reports are typically issued. On any given day, traders will respond to European news and data and adjust prices accordingly for several hours until U.S. data is released.

Watching the data reports

Country-specific economic reports, such as Dutch retail sales or Italian industrial production, are increasingly disregarded by the forex market in favor of Eurozone aggregate economic data. However, German and French national economic reports can still register with markets as they represent the two larges Eurozone economies. Here’s a list of the major European data reports and events to keep an eye on:

• European Central Bank (ECB) interest rate decisions and press conferences after ECB Central Council meetings: This is when the ECB president explains the ECB’s thinking and offers guidance on the future course of interest rates.
• Speeches by ECB officials and individual European finance ministers.
• EU-harmonized Consumer Price Index (CPI), as well as national CPI and Producer Price Index (PPI) reports
• EU Commission economic sector confidence indicators.
• Consumer and investor sentiment surveys separately issued by three private economic research firms known by their acronyms: Ifo, ZEW and GfK.
• Industrial production
• Retail sales
• Unemployment rate