‘ﬂight to quality’trades. In such circumstances, this usually means a move into either the dollar, the Swiss francor gold.24.1.1 Subjective InterpretationThe above are all factual considerations and can be observed by reading any reputable ﬁnancialjournal. However, it is the subjective interpretation of these elements that makes a market andcauses some of the violent gyrations. The foreign exchange market is a dealing environmentwhere the participants, for the most part, have at their disposal all the tools and informationtechnology they need to make money. Most surround themselves with charts, Reuters andTelerate screens, and all have in-house economists to interpret economic trends. Thus, psychology, perceptions, expectations of future growth or political developments or what othersexpect (the safe haven concept), what has been and has not been discounted, and where therelative risks are or might be – all play their part (see Figure 24.1). Market operators look at all
Figure 24.1 The psychology of major markets. Reproduced by permission of 4CAST LimitedSource: 4castweb.com
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these factors when trying to anticipate where the next pressure point will be and to outguessthe rest of the market.
24.2 TECHNICAL APPROACHThe technical approach comprises two basis elements: charting and technical analysis.
r Charting involves the analysis of charts using various methods – for example, movingaverages, reversal formations, point and ﬁgure charts, and trend line analysis.
r Technical analysis is the study and interpretation of price movements to determine futuretrends.A technician will assume that all fundamental factors are reﬂected in the price and that historytends to repeat itself. The tools used by a technician are charts (bar, point and ﬁgure, linecharts), mathematical models (moving averages, relative strength index, directional movementindex), and behavioural models (Elliot wave theory and cycles).
CONCLUDING REMARKSThus, participants in the foreign exchange markets base their decisions to buy or to sell foreigncurrencies on two types of analyses:
r Fundamental analysis, which is primarily the study of the relative economic, ﬁscal, monetary
and political trends of the countries whose currencies are being traded. This type of analysiswill lead to conclusions regarding relative investment values and currencies that may bebought and sold as a result.r Technical analysis, where the philosophy states that price action itself embodies all information about the commodity and that trends and price behaviour can be analysed to maketrading decision.In reality, fundamental analysis of foreign exchange rates is a good background study, but apoor trading tool. On the other hand, technical analysis is a tactical tool used by speculatorsand traders, as the basis for position taking.
25Fundamental AnalysisFundamentals focus on ﬁnancial and economic theories, as well as on political developmentsto determine forces of supply and demand. In essence, fundamental analysis comprises theexamination of macroeconomic indicators, asset markets and political considerations whenevaluating a nation’s currency in terms of another. Within this study, such ﬁgures as measuredby Gross Domestic Product, interest rates, inﬂation, unemployment, money supply, foreignexchange reserves and productivity, are all considered.Asset markets considerations comprise stocks, bonds and real estate, while political considerations impact the level of conﬁdence in a nation’s government, the climate of stability andlevel of certainty. Sometimes, governments stand in the way of market forces impacting theircurrencies and, hence, intervene to keep currencies from deviating markedly from undesiredlevels. Alternatively, some countries can manage to move their currencies merely by hintingor threatening to intervene.
25.1 PURCHASING POWER PARITYThe Purchashing Power Parity (PPP) theory states that exchange rates are determined by therelative prices of similar baskets of goods. Changes in inﬂation rates are expected to be offsetby equal but opposite changes in the exchange rate. For example, if a bottle of Coke costs $2 inAmerica and £1 in England, then, according to PPP, the pound–dollar exchange rate must be2 dollars per 1 British pound. If the prevailing market exchange rate is $1.7 per British pound,then the pound is said to be undervalued and the dollar overvalued. The theory then assumesthat the two currencies will eventually move towards the 2:1 relation. Therefore PPP’s majorweakness is that it assumes goods are easily tradable, with no costs to trade such as tariffs,quotas or taxes.
25.2 INTEREST RATE PARITYThis states that an appreciation or depreciation of one currency against another currency mustbe neutralized by a change in the interest rate differential. For example, if American interestrates exceed Japanese interest rates, then the American dollar should depreciate against theJapanese yen by an amount that prevents riskless arbitrage.
25.3 BALANCE OF PAYMENTS MODELThis model holds that a foreign exchange rate must be at its equilibrium level, i.e. the ratethat produces a stable current account balance. For example, a nation with a trade deﬁcit willexperience a reduction in its foreign exchange reserves, which ultimately lowers (depreciates)the value of its currency. The cheaper currency renders the nation’s exports more affordable inthe global marketplace while making imports more expensive. After an intermediate period,
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imports are forced down and exports rise, thus stabilizing the trade balance and the currencytowards equilibrium.Like PPP, the balance of payments model focuses largely on tradable goods and services,while ignoring the increasing role of global capital ﬂows. In other words, money is notonly chasing goods and services, but, to a larger extent, ﬁnancial assets such as stocks andbonds.
25.4 ASSET MARKET MODELEconomic variables such as growth, inﬂation and productivity are no longer the only driversof foreign exchange movements. The proportion of foreign exchange transactions stemmingfrom cross-border trading of ﬁnancial assets has dwarfed the extent of currency transactionsgenerated from trading in goods and services.The asset market approach views currencies as asset prices traded in an efﬁcient ﬁnancialmarket. As a result, currencies are increasingly demonstrating a strong correlation with assetmarkets, particularly equities.
25.5 ECONOMIC INFLUENCES ON THE MARKETAs mentioned previously, currency forecasters traditionally look at the economic factors of acountry to help them to determine the direction of a country’s currency. Below is a more indepth analysis of the more important economic factors that have to be taken into considerationand cannot be ignored when announced.25.5.1 Consumer Price IndexCPI is a measure of the average level of prices of a ﬁxed market basket of goods and servicespurchased by consumers. The monthly reported changes in CPI are widely followed as aninﬂation indicator. The CPI often excluds the price of food and energy, as these items aregenerally much more volatile than the rest of the CPI and can obscure the more importantunderlying trend. Rising consumer price inﬂation is normally associated with the expectationof higher short-term interest rates and may therefore be supportive for a currency in the shortterm. However, a longer term inﬂation problem will eventually undermine conﬁdence in thecurrency and weakness will follow.25.5.2 Durable Goods OrdersThis is a measure of the new orders placed with domestic manufacturers for immediateand future delivery of factory hard goods. Monthly percent changes reﬂect the rate ofchange of such orders. The levels of, and changes in, durable goods orders are widely followed as an indicator of factory sector momentum. More often than not, the indicator excludes defence and transport orders because these are generally much more volatile thanthe rest of the orders and can obscure the more important underlying trend. Rising ordersare normally associated with stronger economic activity and can therefore lead to highershort-term interest rates, which are often supportive of the currency, at least in the shortterm.
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25.5.3 Gross Domestic ProductGDP is the broadest measure of aggregate economic activity available. Reported quarterly,GDP growth is widely followed as the primary indicator of the strength of economic activity. It represents the total value of a country’s production during the period and consists ofthe purchases of domestically produced goods and services by individuals, businesses, othercountries and the government. A high GDP ﬁgure is often associated with the expectations ofhigher interest rates, which is frequently positive for the currency, at least in the short term,unless expectations of increased inﬂation pressure is undermining conﬁdence in the currencyat the same time.25.5.4 Housing StartsThis is a measure of the number of residential units on which construction has begun eachmonth and is widely followed in order to assess the commitment of builders to new constructionactivity. High construction activity is usually associated with increased economic activity andconﬁdence. It is therefore considered a harbinger of higher short-term interest rates and canbe supportive of the currency in the short term.25.5.5 Payroll/employmentThis is a measure of the number of people being paid as employees by non-farm businessestablishments and units of government. A monthly change in payroll/employment reﬂects thenumber of net new jobs created or lost during the month and changes are widely followed as animportant indicator of the economic activity. Large increases in payroll/employment are seenas signs of strong economic activity. This could eventually lead to higher interest rates, whichwould be supportive of the currency, at least in the short term. If however, inﬂationary pressuresare seen to be building, this may undermine the longer term conﬁdence in the currency.25.5.6 Producer Price IndexProducer Price Index (PPI) is a measure of the average level of prices of a ﬁxed basket ofgoods received in primary markets by producers. The monthly reports are widely followed asan indication of commodity inﬂation. The PPI often excludes the food and energy componentsas these items are normally much more volatile than the rest of the PPI and can thus obscure themore important underlying trend. A rising PPI is normally expected to lead to higher consumerprice inﬂation and thereby to potentially higher short-term interest rates, which in effect willhave a short-term positive impact on the currency. However, signiﬁcant inﬂationary pressurewill often lead to an undermining of the conﬁdence in the currency involved.25.5.7 Retail salesThese are a measure of the total receipts of retail stores. Monthly percentage changes reﬂectthe rate of change of such sales and are widely followed as an indicator of consumer spending.They are generally followed less auto sales, because they are generally more volatile and canhence obscure the more important underlying trend. They are measured in nominal terms andinclude the effects of inﬂation. Rising retail sales are often associated with a strong economy
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and therefore an expectation of higher short-term interest rates is often supportive for thecurrency, at least in the short term.25.5.8 Trade balanceThe trade balance is a measure of the difference between imports and exports of tangible goodsand services, and is a major indicator of foreign exchange trends. Seen in isolation, measuresof imports and exports are important indicators of overall economic activity in the economy.Typically, a nation that runs a substantial trade balance deﬁcit has a weak currency due tothe continued commercial selling of the currency. This can, however, be offset by ﬁnancialinvestment ﬂows for extended periods of time.
CONCLUDING REMARKSThe forces of supply and demand determine the value of currencies and there are, as mentionedbefore, two radically different methods of predicting where the forces of supply and demandare heading. The ﬁrst method, fundamental analysis, focuses on macroeconomics. By studyingeconomic reports and or political developments, fundamental analysts interpret changes in theunderlying factors that cause foreign exchange rates to ﬂuctuate. The other type of analysis,practised by technicians, primarily makes judgements based upon price data displayed oncharts.
26Key Factors Impacting CurrenciesOn certain occasions, foreign exchange rates immediately reﬂect changes in economic conditions, while, on other occasions, the market adjusts only after a period of delay. In general,foreign currency traders will tend to focus on released information that will have an impact onthe market within a matter of hours; this means that they will not hold very long positions as theodds of an unpredicted development effecting exchange rates increases with time. Therefore,to minimize market risk, traders tend to enter and exit the market quickly, while looking forideas that, if sound, will produce short-term proﬁts.The following is a guide to the essential fundamentals and practical factors impacting keyforeign exchange rates against the dollar.
26.1 FACTORS AFFECTING THE YEN AGAINST THE DOLLARAsian markets and currencies generally move with the yen because Japan is the economicengine for the region. Economic problems, and/or political instability in particular countries,often affect Japanese companies and banks, which are heavily invested in the region, andtherefore Asian instabilities undermine the yen. However, the major factors affecting the yenagainst the dollar are:
r Ministry of Finance (MoF). This is the single most important political and monetary institution and it will often make verbal intervention statements that are aimed at avoidingundesirable appreciation/depreciation of the yen.r Interest rates. The overnight call rate is the key short-term interbank rate. The call rate iscontrolled by open market operations designed to manage liquidity. The Bank of Japan willuse the call rate to signal monetary policy.r Japanese Government bonds (JGBs). The Bank of Japan buys 10- and 20-year JGBs everymonth to inject liquidity into the monetary system. The yield on the benchmark 10-year JGBserves as the key indicator of long-term interest rate spread, or the difference between the10-year JGB yield and those on the American 10-year treasury notes. For example, fallingJGBs (rising JGB yields) will usually boost the yen and weigh on the dollar.r Economic Planning Agency (EPA). This is a government agency that is responsible forformulating economic planning and coordinating economic policies, including employment,international trade and foreign exchange.r Ministry of International Trade and Industry (MITI). This is a government institution principally aimed at defending international trade competitiveness of Japanese corporations.r Economic data. The most important economic data from Japan are:1. Gross Domestic Product2. Tankan Survey (quarterly sentiment and expectations survey)3. International trade4. Unemployment
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5. Industrial production6. Money supply.
r Leading stock index (NIKKEI-225). A reasonable decline in the yen usually lifts stocks ofJapanese export companies, which tends to boost the overall stock index.
r Cross-rate effect. The cross-rate between the euro and the yen (eur/jpy) can have an effect onthe currency. For example, a rising dollar against the yen could be the result of an appreciatingeuro against the yen, rather than as a direct result of a strengthening dollar.An example of fundamentals affecting the yen could be:The dollar turned sharply higher on Friday, USD/JPY apparently leading the charge. Japanesevice Finance Minister Kuroda theorized overnight that ‘massive’ selling of yen would reversethe deﬂationary spiral in Japan, and help boost exports. There was some initial reaction to thecomments, but it wasn’t until the NY afternoon session that yen selling (in very thin market) reallymoved the dollar higher.
26.2 FACTORS AFFECTING THE SWISS FRANCAGAINST THE DOLLARThe Swiss franc moves primarily on outside events and not necessarily on domestic economicnews. The Swiss franc is the world’s premier safe heaven currency and will gain strength inthe following situations:
r Uncertainty over the euror Crisis in the Persian Gulfr Turmoil in emerging markets (especially Russia and Europe).As such crises are resolved, the Swiss franc will then tend to weaken. This safe-haven statusstems from the fact that the SNB retains independence in preserving monetary stability andthe neutrality of Switzerland’s political position. However, other factors that should be takeninto consideration are:
r Swiss National Bank (SNB). The Swiss central bank does not use a speciﬁc money marketrate to control monetary conditions in the market. In effecting, it has maximum independencein setting monetary exchange rate policy. The ofﬁcials of the SNB can affect the Swiss francby making occasional remarks on liquidity or money supply.r Interest rates. The SNB uses the discount rate to announce changes in monetary policy.r Economic data. The most important economic data released out of Switzerland are:1. M3 – broadest in money supply2. Consumer Price Index3. Unemployment4. Balance of payments5. Gross Domestic Product6. Industrial production.
r Cross-rate effect. Such cross rates as the euro against the franc (EUR/CHF) or sterling againstthe franc (GBP/CHF) can affect the dollar against the franc exchange rate. For example, arise in sterling against the franc, triggered by an interest rate hike in Britain, could extendthe Swiss franc’s weakness against other currencies.
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r Other possible factors. Due to the proximity of Switzerland to Germany (Eurozone), thefranc has exhibited a considerably positive correlation with the euro. For example, a suddenmove in the euro against the dollar, perhaps triggered by a major fundamental factor, is mostlikely to cause an equally sharp move in the dollar against the Swiss franc in the oppositedirection.An example of fundamentals affecting the Swiss franc could be:The fact that the Swiss GDP ﬁgures were delayed perhaps should have given clues as to how badthe ﬁgures were going to be. The state of the economy would suggest that those with safe havenmoney parked in the franc might want to step up the search for an alternative. The dollar against theSwiss franc was heading up ahead of the releases, though this might also be down to the AmericanFTC clearing Nestlé’s bid for Chef America.
26.3 FACTORS AFFECTING THE EURO AGAINST THE DOLLARAs the euro establishes a track record, it should become widely held as a reserve currency. Thiswill encourage European central banks and others with large dollar holdings to reallocate theirforeign reserves, which could be a long-term positive factor for the euro. Also, as Europeanbanks are quite heavily exposed to emerging markets in Asia and Latin America, any turmoilin emerging markets could hurt the euro and thus hurt GDP.The following factors should also be taken into consideration:
r European Central Bank (ECB). The ECB controls the monetary policy for all the countriesthat adopted the euro (Eurozone), and also has a primary objective of price stability.
r Interest rates. The ECB’s reﬁnancing rate is the key short-term interest rate to monitor.r 10-year government bond. This is another important driver of the exchange rate. The German10-year Bund is normally used as the benchmark.
r Economic data (see Figure 26.1). The most important data come from Germany, being thelargest economy, and the key data are:
Figure 26.1 Euroland economic data. Reproduced by permission of 4CAST LimitedSource: 4castweb.com
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1. Gross Domestic Product2. Inﬂation3. Industrial production4. Unemployment5. German IFO survey (indicator of business conﬁdence)6. Budget deﬁcits of the individual member countries.
r Cross-rate effect (e.g. the euro against the yen). For example, the euro against the dollarcould fall if there was some signiﬁcant positive news from Japan, which will ﬁlter througha falling euro against the yen exchange rate.r Other indicators. There is a strong negative correlation between the euro against the dollarand the dollar against the Swiss franc. In most cases, a spike (dip) in the euro/dollar exchangerate will be accompanied by a dip (spike) in the dollar/franc exchange rate. This mainly occursbecause the Swiss economy is largely dependent on the Eurozone economies.r Political factors. As with all exchange rates, the euro is susceptible to political instability,such as the coalition governments of Germany, Austria and Italy.Examples of fundamentals affecting the euro can be:The past week was broadly a week of two halves for the Eurozone interest rate markets withthe ﬁrst 3 days of the week, through to the end of the 11th September anniversary, seeing asharp sell-off before a partial rebound Thursday/Friday. The catalyst for the early week falls wereMr. Duisenberg’s comments (at the weekend EcoFin meeting) that ‘we regard the present monetarystance, including interest rates, to be suitable for the present situation and the foreseeable future.We expect there will be no shortage of traders looking for EUR/USD buy levels in the early partof the week.’Asia is taking little notice of Chancellor Schroeder’s Social Democrats party extending its opinionpolls lead over the Christian Democrats. The German Daily, Die Welt, reported that Schroeder’sstrong stance against war in Iraq boosted Social Democrats’ lead in the opinion poll. With lessthan 10 days for a general election, the German daily reported that two opinion polls to be releasedlater today showed the SPD leading 3 percentage points ahead of the opposition conservatives.Market continues to focus on US stocks and data releases later today.
26.4 FACTORS AFFECTING STERLING AGAINST THE DOLLAR
r Bank of England (BoE). In 1997, the British central bank obtained independence in settingmonetary policy in order to deliver price stability, and this objective is set by the government’sinﬂation target. Perhaps it is not so independent, as the BoE remains dependent upon havingto meet the inﬂation target set by the Treasury.r Interest rates. Minimum lending rate (base rate) is the main interest rate the market watches.The BoE will also set monetary policy through its daily market operations.r Gilts. These are government gilt-edged securities. The market will look to the spread differential between the yield on the 10-year American treasury note and the yield on the 10-year gilt.r Treasury. The Treasury sets the inﬂation target for the BoE, even though their role in settingmonetary policy has diminished sharply since the BoE was given its independence in 1997.r Sterling and European membership. Every time the Prime Minister in Britain makesreferences regarding Britain’s possible membership into the single European currency, theforeign exchange market tends to react. In essence, if the British public were to vote infavour of joining, British interest rates would have to converge to the same levels as thosein Europe and sterling would have to be depreciated.
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r Economic data. The most important data items to watch are:1. Unemployment2. Average earnings3. Retail sales4. Producer Price Index5. Industrial production6. Gross Domestic Product growth7. Purchasing managers’ surveys8. Money supply9. Housing prices.
r Leading stock index (FTSE-100). There is a correlation between the FTSE-100 and the DowJones Industrial Index which happens to be one of the strongest in the global markets.
r Cross-rate effect. Since sterling is outside the Eurozone, it is a popular safe haven fromeuro doubts. The key rate to watch is the euro against sterling cross (EUR/GBP) for theeuro situation as well as other safe-haven plays. Also, if there were a strengthening of thepossibility of British membership into the euro, this would lead to a rise in the euro againstthe pound and would lead to a decline in the pound against the dollar. Conversely, reportsthat Britain may not join the single currency will hurt the euro against the pound, therebyboosting sterling.An example of fundamentals affecting sterling is:While the traders are focusing on the frenetic activity in EUR/JPY that has set off stops just over118.20 and jumped to 118.41; GBP/JPY has beneﬁted just as much from JPY weakness. Froma fundamental perspective, GBP looks like an even better buy vs JPY due to the relatively goodcondition of the UK economy vs Euroland. Longer term investors have pushed GBP/JPY to 188.30,the highest price since the end of July. Dealers say that if the day’s high of 188.42 is breached, thetarget on the upside is 189.90 which has not been seen since mid April. (Source: 4castweb.com)
26.5 FACTORS AFFECTING THE AMERICAN DOLLAR
r Federal Reserve Bank (Fed). The American central bank has full independence in settingmonetary policy. Its chief policy signals are open market operations, the discount rate andthe Fed Funds rate.r Federal Open Market Committee (FOMC). This committee is responsible for making decisions on monetary policy, including the crucial interest rate announcements it makes eighttimes a year.r Fed Funds rate. This is clearly the most important of all American interest rates. It is the ratethat depository institutions charge for overnight loans. The Fed will announce changes in therate when it wishes to send clear monetary signals to the market, and these announcementswill generally have a major impact on all stock, bond and currency markets.r Discount rate. This is the interest rate at which the Fed charges commercial banks foremergency liquidity, and is mostly a symbolic rate. However, changes in the discount rateimply clear policy signals.r 30-year Treasury bond. This is perhaps the most important indicator of the market’s expectations on inﬂation. Being a benchmark asset-class, the long bond is normally impacted byshifting capital ﬂows triggered by various considerations. Financial and political turmoil in
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emerging markets could be a possible booster for US treasuries for their safe nature, therebyhelping the dollar.r 10-year Treasury note. The foreign exchange markets usually refer to the 10-year note whencomparing its yield with that of bonds overseas. A higher American yield usually beneﬁtsthe dollar against foreign currencies.r Treasury. The Treasury is responsible for issuing government debt and for making decisionson the budget. The Treasury has no say in monetary policy but statements on the dollar havequite an inﬂuence on the currency.r Economic data (see Figures 26.2 and 26.3). The most important release are:1. Labour report (payrolls, unemployment rate and average hourly earnings)2. Consumer Price Index3. Producer Price Index4. Gross Domestic Product5. International trade6. NAPM7. Housing starts and housing permits8. Industrial production9. Consumer conﬁdence.
r Stock market. There are three major stock indexes: the Dow Jones Industrials Index (Dow),S&P 500 and NASDAQ. The Dow is the most inﬂuential index on the dollar. The threemain forces affecting the indexes are corporate earnings (forecast and actual), interest rateexpectations, and global considerations.r Cross-rate effect. The dollar’s value against one currency is sometimes impacted by anothercurrency that may not involve the dollar. For example, a sharp rise in the yen against theeuro could cause a general decline in the euro, including a fall in the euro against the dollar.
Figure 26.2 US economic data. Reproduced by permission of 4CAST LimitedSource: 4castweb.com
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Figure 26.3 Global economic data. Reproduced by permission of 4CAST LimitedSource: 4castweb.com
Some examples of the dollar being affected by fundamentals factors could be:The week centered on the ﬁrst anniversary of the September 11th terrorist attacks on the US,with the days prior to Wednesday characterised by further reduction of risk, which in FX termsmeant trimming back short USD positions. The day itself saw a gentle exploration of long USDpositioning which appeared based on little more than an outbreak of patriotism, but while the USDrally did have more legs than that in the stock markets, the approach of Fed Chairman Greenspan’stestimony to the House Budget Committee, President Bush’s speech to the United Nations (bothThursday) and US retail sales data followed by the Michigan CSI (Friday) ensured that risk proﬁlesremained low. Mr Greenspan walked the usual center line, though did concede that the Fed’s Julyforecasts on the US economy ‘would somewhat lower’ if re-estimated today. The retail sales datawas better than expected, the Michigan was worse.On the Iraq front, UN developments next week may ultimately determine the greenback’s mediumterm direction, so USD gains posted today may be ﬂeeting. A busy week on the data calendarnext week brings July business inventories on Monday, August industrial production/capacityutilization on Tuesday. August CPI is on tap Wednesday, along with the July trade report andAugust real earnings. On Thursday, August housing starts and the September Philly Fed surveywill be released. (Source: MMS)
27Technical AnalysisIn an earlier chapter, it has been mentioned that the technical approach comprises two elements,charting and technical analysis, which is the study and interpretation of price movements inorder to determine future trends. A technician assumes that all fundamental factors are reﬂectedin the price and that history tends to repeat itself. The tools of a technician are bar charts, pointand ﬁgure charts, and line charts. Techicians will use mathematical models, such as movingaverages, relative strength index (RSI) and directional movement index (DMI), and will alsostudy behavioural models, such as Elliot Wave theory and cycles.Technical analysis examines past price and volume data to forecast future pricemovements.
27.1 ASSUMPTIONSAll technical analysis is based upon the following three assumptions.1. All publicly available information about a tradable currency is already in its price.2. Prices move in trends or patterns.3. History repeats itself.Thus, as a direct consequence of the ﬁrst assumption, technicians believe there is little proﬁtto be gained by researching economic fundamentals. This research will lead to an explanationof the current price rather than an accurate prediction of the future price. Hence, technicianslook at charts to identify patterns and trends. They have found that currency prices do notﬂuctuate randomly, like the chaotic scrawl of a small child, but instead follow distinct patterns,like the crest and peaks of waves. By trying to identify known patterns or discernible trendsin the early stages of their development, technicians predict rate movement based upon thehistorical continuations of those movements.Technicians ignore statements by politicians and government ofﬁcials. If the statement isimportant, it will be reﬂected in the foreign exchange rate. For example, if Alan Greenspan, thehead of the American Federal Reserve (central bank) said that the American Federal Reservewould cut interest rate in the near future, fundamental analysts would immediately buy Swissfrancs, euros and yen in exchange for dollars. This is because a lowering of American interestrates (or an increase in its probability) would make the dollar a less attractive investmentcompared to other currencies. The selling of dollars by traders who follow fundamentalswould trigger a downward movement in the dollar against other currencies.The technicians who were watching charts while Greenspan spoke would notice a plungein the dollar on the charts. As different exchange rates began new trends, technicians wouldchange their foreign exchange positions in the market. In this scenario, the technicians followthe lead of the fundamental analysts.
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Technicians follow trends – they do not start market movements.Fundamental analysts have the ability to follow a limited number of topics at one time. Ifa technician is occupied listening to Greenspan giving a speech, it is not usually possible tofollow the events that are going on in Germany or Latin America. Thus, the technician indirectlythrough price movements may have a more complete perspective of all the unfolding activitythan a fundamentalist.
27.2 THE BASIC THEORIESThe Dow theory is the oldest theory in technical analysis and states that prices fully reﬂect allexisting information. This theory was developed primarily around stock market averages andholds that prices progressed into wave patterns which consisted of three types of magnitude:primary, secondary and minor. The time involved ranged from les than three weeks to overa year. The theory also identiﬁed retracement patterns, which are common levels by whichtrends pare their moves. Such retracements are 33%, 50% and 66%.27.