Approaches To Market Analysis

  1. Fundamental Analysis – is the study of data using economic theories.
  2. Technical Analysis – is the use of history, graphs, charts and the like to define the market.

A. Fundamental Analysis

To understand why foreign exchange rates fluctuate, begin by assuming that currency is a commodity subject to the laws of supply and demand. At any time the price of one currency in terms of another, is set at that point where supply equals demand, given a free market.

Major fundamental factors influencing currency supply and demand are as:


  1. Balance of payments

  2. Governmental influences

  3. Public opinion or sentiment

Balance of Payments

A country’s balance of payments is the net inflow or outflow of a country’s currency once it has summed up all its transactions with other countries. These transactions include exports of goods and services, foreign investment in that country, import of goods and services, investments made abroad by that country’s citizens, foreign aid and government-directed Central Bank transactions.

A country’s balance of payments is the barometer of supply and demand for its currency. Example: If a country has more exports than imports, foreigners are seeking the country’s currency to buy its products. If domestic investments are attractive to foreigners, this also creates demand for that country’s currency. When a country carries a deficit balance of payments, its currency becomes more available on world markets and may command a lower price.

Governmental Influences

  1. See “pegging system” – Bretton Woods, 1944.
  2. Internal and external government policy:

Governments will intervene in the currency market through their central banks or treasuries when they consider their currency either overbought or oversold. This can be an individual attempt to stabilize the nation’s currency, an informal arrangement among nations, or required action among EMS (European Monetary System) participating members operating the ERM. (Exchange Rate Mechanism). If it is a nation’s objective to raise its currency’s value, it uses its reserves or foreign currencies to buy its own currency and take it off the market. Conversely, if they seek to lower their currency’s value, they sell their currency, thereby increasing market supply and lowering its value.

Internal policy will also impact currency value. By lowering interest rates, lendable funds will flow out of the country, thus weakening that currency and vice-versa by raising interest rates.

Interest rate parity~ Investors want the currency with the highest interest rate now to earn that rate. For example, if British interest rates rise above U.S. rates investors will want pounds now and will bid up the British pound exchange rate, which will be reflected in the spot price. Interest rates and money supply are often adjusted to address the rate of inflation. Inflation is simply “too much money seeking too few goods”, or, an increase in price without a corresponding increase in quality or service.

By definition, fundamental analysis is the study of specific factors, such as weather, wars, discoveries, and changes in Government policies, which influence supply and demand, and consequently prices in the market place. They may be classified, as follows:

EXTERNAL FACTORS

  • Financial & Economic changes
  • Political Factors
  • Central Banks’ Joint Intervention
  • Rumors
  •  War

ECONOMIC CHANGES

  •  Inflation Rate
  •  Money Supply M1 – deposit, M2- CD, most significant savings, M3- time deposits of S 100,000 up, M4‑ long term liquid assets / saving bonds.
  • Interest Rate – Bond prices down, interest rate up, mortgage rates up, yields up.
  • International Trade
  • Unemployment Rate
  • Disposable Income
  • Trade Deficit / Surplus

INTERNAL FACTORS

  • Technical Adjustment
  • Government Intervention
  • Psychological Influence – historical highs and lows in price movement

Description of Economic Indicators

  1. Trade Deficit – When the export value of goods is smaller than the import value, the outflow of currency results.
  2. Balance of Payments – A statement in which all the revenues and expenditures of a country is recorded.
  3. Gross National Product – This figure reflects the growth and the economic situation of a country.
  4. Unemployment Rate – A rate showing the percentage of the unemployed workers within the total population.
  5. Non-Farm Payroll – This figure reflects the health of the commercial and industrial sector of an economy. The size of this figure is positively related to the growth rate of an economy.
  6. Industrial Production – It shows the industrial output of an economy. The higher the figure, the better the economy.
  7. Factory Orders – The amount of orders received by manufacturers. The higher the figure, the stronger the price of a country’s currency, reflecting the anticipated future strength of the economy.
  8. Business Inventory – Unsold output. When this figure is high, an economy is slow and the currency of this country would be weakened.
  9. Capacity Utilization – This figure is high when an economy is strong. A high figure is beneficial to the currency of a country.
  10. Leading Indicators- Can be used to predict the health of an economy. A high figure reflects high inflationary pressures. The following indices are related to inflation.
    1. Consumer Price Index – Reflects the trend of the average price of consumer goods, This figure is positively related to inflation.
    2. Producer Price Index – Reflects the trend of producer costs. This figure is positively related to inflation.
    3. Retail Sales – Reflects the purchasing strength of an economy.
    4. Personal Income – Shows the growth in average income.
    5. Personal Consumption Expenditure (PCE) – Shows the growth in average expenditure.
    6. Prime Rate – The interest rate (lower than the market interest rate) charged to highly reputable (“prime”) customers.
    7. Discount Rate – Interest charged by the central bank to commercial banks when borrowing money. Higher market rates, influenced by the Discount Rate, attract short term inflow of investments.
    8. Federal Funds Rate – The interbank rate for borrowing or lending reserves to meet margin requuirements.

Foreign Exchange Market Influences

A. Gross National Product (GNP)

Nominal GNP is the value, at current market prices, of all finished goods and services produced within a specific period by a nation.

Real GNP is the nominal GNP corrected for inflation, An increase in real GNP indicates the increase in the physical volume of output for that period and excludes any price increases.

GNP indicates two particulars; economic growth and inflation. It can be determined by four
(4) basic components:

GNP = C + I + G + NE
Where
C   = Consumer Spending (household + company)
I    = Investments (savings ‑ unused consumption)
G   = Government Spending, and
NE = Net Exports (Exports ‑ Imports)

If one of the 4 components changes its value, GNP will change accordingly and this will trigger a change in the US. Dollar.

Consumer Spending – covers 3 economic indicators:

  1. Car Sales – signifies number of new cars sold by producers, but not the total value sold nor does it include any purchase of old cars.
  2. Durable Goods Orders – durable goods consist of equipment or machines that are normally expected to last longer than 3 years (e.g. computers, trucks, automobiles).
  3. Retail Sales – includes the value of household commodities – supermarket and department store sales, construction materials, electrical, appliances, car sales, etc.

Gross Domestic Product (GDP)

The market value of all final goods and services produced within a nation’s border in a given time period. Prior to 1992, most U.S. statistics focused on GNP. In an increasingly global economy, the calculation of GNP became even more complex. GNP would include output from Apple computer factory in Singapore, but exclude some output of Honda in Ohio.

GDP is geographically focused on all output locally may it be a foreign brand.

B. Inflation Indicators

This reflects inflation and cost of living.

  1. Consumer Price Index (CPI) – is the most widely used index of the cost of living. It is the price index of the cost of a fixed basket of consumer goods in which the weight assigned to each commodity is the share of expenditures on that commodity by urban consumers. This is important to consider in an inflationary period where inflation is the main concern of the economy.
  2. Producer Price Index (PPI) – is the price index of goods sold at the wholesale level (e.g.. steel, oil, wheat).
  3. Unemployment Rate – shows the percentage of the unemployed workers within the total population.

C. Personal Income.

D. Industrial Production – shows industrial output of an economy.

E. Housing Starts – is the amount of new housing construction.

F. Budget Deficit – is the excess of total expenditures over total receipts, with borrowing not included among receipts. This difference is ordinarily financed by borrowing.

G. Current Account – is the record of the flow of goods and services between countries.

  1. Balance of Payments – is the record of transactions between residents and the rest of the world.
  2. Interest Rate – is the price paid for borrowing money for a period of time.
  3. Political Situations

Eurodollars and the Foreign Currency Markets

Eurodollars

When U.S. dollars are deposited in banks in countries outside the United States and the deposits remain denominated in U.S. dollars (,rather than being converted into the local currency), those deposited dollars are known as Eurodollars. Because of long-standing tradition, the prefix Euro is used even when the U.S. dollars are deposited in banks in non-European countries such as Japan, Brazil and Australia. Banks accept deposits of many currencies in addition to U.S. dollars that are foreign to their own countries, and the term “Eurocurrency” is generally applied to these non-U.S. dollar deposits.

Eurodollars that are taken in deposits by banks are used as the basis for loans to individuals, corporations and governments that need U.S. dollars for their transactions. The foreign demand for U.S. dollars is due in part to the growing acceptance of U.S. dollars as an international medium of exchange and in part to the sheer number of transactions occurring overseas with American corporations.

Eurodollar time deposits tend to be short-term, ranging from overnight to 180 days. European banks lend Eurodollars among themselves in much the same way that U.S. banks lend federal funds (to meet dollar deficits or to invest dollar surpluses), and even American banks borrow and lend U.S. dollars in the Eurodollar market.

Eurosecurities

One of the common types of Eurosecurities is the Eurobond, which is any long‑term debt instrument that is issued and sold outside the country of the currency in which it is denominated. Thus, a U.S. dollar-denominated Eurobond is a bond issued and sold outside the United States, but for which the principal and interest is stated and paid in U.S. dollars.

U.S. dollar-denominated Eurobonds are issued by foreign businesses, foreign governments and foreign branches of U.S. corporations. Borrowers (particularly U.S. corporations) can reach new sources of revenue and avoid the regulatory requirements and expense of selling bonds in the domestic U.S. market.

Due to the unregulated nature of the Eurobond market, investors usually demand a higher return because there are fewer safeguards. The interest rates paid by Eurobonds are typically higher than those paid by comparable domestic bonds.

Eurocurrency loans. The London Interbank Offered Rate (LIBOR) is the rate that most international banks dealing in Eurodollars charge each other for Eurodollars loans. (LIBOR) is the rate from which many international interest rates are calculated.

B. Technical Analysis

Major Trends in Chart Analysis

A. Trends

  1. Uptrend – series of successively higher peaks and troughs
  2. Downtrend – series of declining peaks and troughs
  3. Sideways – horizontal peaks and troughs

B. Major Support (troughs)

  1. price level or area on the chart where buyer interest is sufficiently strong enough to overcome or digest selling pressure and a price decline is turned back up again.
    Major Resistance (peak) – price level or area over the market where selling pressure overcomes or digests buying pressure and a price advance is turned back.

C. Significance of a Trendline

  1. The longer the trendline has been intact, the more significant the trendline. The more the number of times the trendline has been tested, the stronger the trendline.

D. Validity of Trendline Violation

  1. The price filter used is a 1% or 3% penetration criteria to eliminate whipsaws. A closing price penetration beyond the trendline is more significant than just an intra ‑ day penetration.
  2. The time filter requires that prices close beyond the trendline for 2 successive days.

Technical Analysis

Basic: Support & Resistance

Support and resistance levels are unquestionably among the most important of all technical considerations. They are areas, which prices are expected to have difficulty moving beyond, and they therefore deserve especially careful considerations in buying and selling decisions. Support and resistance levels on bar chart can be divided into three basic categories: 1) congestion areas, 2) areas at which previous advances and declines were turned back, and 3) transformed support and resistance levels-i.e., former highs that have been penetrated and thereby turned into support levels. The basic idea behind resistance and support theory is simply that price level that were significant in the past will have significant impact on price action in the future.

Trends

The first trend theory holds that an uptrend remains intact as long as each successive intermediate high than those preceding it and each reaction stop at a higher point than did earlier reactions. Conversely, a downtrend prevails when each intermediate decline carries price falling short of earlier rallies.

Continuation Pattern

Flag and Pennant

The parallelogram and triangle formations that sometimes form after a rapid vertical move indicates that another similar move is likely to follow. Technicians often follow that flags mark the half way point of a price move, measuring from the level decisive break away from the previous formation.

Many chartist mark flags and pennants among the most dependable signals, particularly with reference to the direction of the impending move.

Triangles

Triangles can be continuation or reversal patterns, but seem to fall on the former category more often. They appear when there are simultaneous short-term uptrend and downtrend lines which intersect. The conventional chart interpretation holds that triangles signal impending large move , with the direction of the move likely to be in the direction of the steeper trendline. An Ascending Triangle is likely to breakout in either direction. Subjectively, triangles appear to be fairly reliable indicators, especially when no more than tree of four oscillations occur before the breakout.

Gaps

Gaps are simply areas within the boundary of activities where no actual trading occurred. Technicians generally place gaps into one of these four categories: Common Gaps are blank areas between tow conservative’s days trading ranges, within which activity place in the recent past. They are usually considered tops and have meaning. Break Away Gaps occur when prices suddenly explode out of a considerable length of time ( or in which no trading has ever taken). Run Away Gaps appear following an already substantial price move, while Exhaustion Gaps are supposed to make the final stages of a major move.

Reversal Formations

Reversals

The reversal on either a daily or weekly chart is simplest of trend change formations. A downside reversal occurs when the price registers a new high during the course of a day (or week) and then closes the day (or week) sharply lower. Price action immediately following a daily or weekly reversal varies considerably. In some cases key reversals make the beginning of dramatic retracements of the preceding move, while in others the reversals simply mark the beginning of a more gradual trend change.

Island Reversal

These are small top or bottom formation set apart by gaps on either side. The island consists of a single day or reversal days, and the entire formation is closely related to the daily or weekly reversal phenomena. The key difference is simply that following the gap on the island area, prices hold for on more several days before the buying(or selling) power disappear between trading sessions.

Double Top or Bottom

This patterns form when successive intermediate term highs, or low stops approximately the same level. A double top is considered complete only if the decline from the second peak carries prices below the first stopping point. Double top can be subdivided into two rather instinct types, which might be called short-range and long-range. Short-range double tops generally form between 8 to 10 weeks and result form the kind of activity described as “previous high as Resistance.” Long-range double tops develop over much longer intervals and are frequently associated with a widespread reluctance to pay prices above many levels that have gained a certain historical respect. For psychological reasons, round numbers are often especially likely areas for longer-range double tops.

Head and Shoulder Formation

The head and shoulder top (as well as the inverted head and shoulder bottom) has historically one of the most popular and widely followed of chart formations. The left shoulder result from an advance followed by a relatively similar decline, the head is formed by a large rally falling short of the top of the head and subsequent decline that carries prices below the line connecting the body joints of the head – called the “neckline.” Several ideas concerning head and shoulder formation have gained widespread acceptance by technicians. First, the patter is not complete until the neckline is decisively penetrated. Unless and until this occurs no reversal is considered given. Second, after this confirming penetration, prices frequently rally back to the vicinity of the neckline before the final move begins. Third, the vertical distance form the top of the head to the neckline provides a measure of the extent of the decline likely to occur from the neckline before the final begins. The existence of this concrete measuring rule perhaps accounts for part of this information popularity among chartists. Fourth, a market is considered extremely vulnerable to step decline if the rally is forming the right shoulder is unable to carry as afar as the top of the left shoulder.

Round Tops and Bottoms

These patterns also known as saucers or bowls, occur during a very gradual trend change, but often harbingers of sizable price moves. They are rather uncommon and tend to develop often in relatively thin markets.

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